Korean Stocks to Rally as Rate Rises Won't Slow Economy, Prudential Says

South Korean stocks may extend their longest rally in five years as “modest” increases in interest rates will slow inflation without damaging economic growth, according to Prudential International Investments Advisers LLC.

The Kospi stock index will likely rise about 7 percent to 1,900 by the end of this year, John Praveen, the Newark, New Jersey-based chief investment strategist at Prudential International, said in an e-mail interview. The stock gauge rose 0.9 percent to 1,778.43 at 12:53 p.m., extending this quarter’s advance to 4.7 percent. It posted a sixth quarterly advance at the end of June, the longest stretch of increases since 2005.

“The growth outlook for Korea remains solid and should support Korean stocks,” said Praveen. He expects the economy to grow 6 percent this year, above the central bank’s forecast of 5.9 percent. Stocks will also rise on “attractive” valuations and as global fund managers reverse their underweight allocations for the Asian nation, he said.

Even with a 5.7 percent gain for the Kospi index this year, the gauge trades at 9.7 times estimated earnings, the lowest in Asia after Pakistan’s 7.1 multiple and Vietnam’s 9.5 times.

Praveen’s view is shared by John Wong, a portfolio manager for Oberweis Asset Management Inc., who said South Korean stocks are among the “most attractive” in the region and may post further gains.

“Many Korean companies are generating an increasing percentage of their sales from China,” which should buffer any slowdown in the U.S. or Europe, Wong said in an interview on Aug. 5. “Kospi’s valuation is among the most attractive in Asia.”

Inflation Outlook

The Bank of Korea last week left its benchmark interest rate unchanged as global risks cloud Asia’s recovery, while signaling future increases to stem price pressures. The move followed the bank’s decision to lift rates to 2.25 percent in July from a record-low 2 percent.

Any negative effects from higher financing costs are likely to be “modest” because the central bank is expected to undertake “a gradual and moderate” withdrawal of monetary accommodation, Praveen said. The central bank may increase rates to 2.75 percent to 3 percent by the end of this year, he said.

“Rates will remain low even after the Bank of Korea raises the base rate,” Praveen said. “Modest rate hikes will increase the credibility of the Bank of Korea which will be seen as proactive and ahead of the curve in fighting inflation.”

Consumer prices rose 2.6 percent last month from a year earlier, within the central bank’s target of between 2 percent and 4 percent on average through 2012. Producer-price inflation cooled in July from a 16-month high, advancing 3.4 percent.

South Korea, Asia’s fourth-largest economy, grew 1.5 percent last quarter from three months earlier as exports surged and local demand revived. The economy will grow 5.9 percent this year, more than the 5.2 percent predicted in April, the central bank said on July 12.

“Exporters such as car manufacturers are also benefiting from the relatively weaker won compared with the yen,” Praveen said.

To contact the reporter on this story: Saeromi Shin in Seoul at sshin15@bloomberg.net.

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