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Game-Changing Developments are Unfolding in the Korean Peninsula

When North and South Korean athletes marched together under one flag during the opening ceremony of the 2018 Winter Olympics, that rare gesture of unity set the tone for what could be a historic year for the Korean peninsula. A series of diplomatic moves since then have cleared a path for negotiations that could finally wrap up the 7-decades-old Korean war and normalize relations between Pyongyang, Seoul and Washington D.C.

This is a remarkable reversal from last year when skyrocketing tensions led to name-calling and threats of nuclear war. Now, all of that seems like yesteryear. Last week, the first telephone hotline was set up between North Koreaʼs Kim Jong Un and South Koreaʼs Moon Jae-in. The two leaders plan to have their first phone conversation before meeting face-to-face at a leadership summit on April 29, where they will discuss de-nuclearization and a peace treaty to officially end their state of war. If all goes well, that will be followed by a separate summit between North Koreaʼs leader and US President, Donald Trump, sometime in May or June.

The dismantling of North Koreaʼs nuclear arsenal – if that is indeed what Kim Jong Un means by de-nuclearization – would be in return for establishing diplomatic ties with the U.S., securing aid to help rebuild its economy, and getting America to approve the Northʼs peace treaty with South Korea.

President Kimʼs sudden about-face has many skeptics wondering whether he has more nefarious objectives in entering the negotiations. Some analysts note that Pyongyang has always shown tactical flexibility to avoid serious confrontations and to get cash and technology when needed. It is therefore possible that North Korea needs additional resources for its weapons development program, and a compromise today will provide access to materials necessary for those next steps.

Others argue that North Korea has been reeling from the economic squeeze of sanctions, including by ally China, and may be eager to end that pain. Also, Kim Jong Un has placed greater emphasis on economic development alongside his nuclear goals since taking power in 2011. That shift could make any offers of financial assistance from the U.S. and its allies more appealing in negotiations.

In the meantime, President Trump has expressed support for peace talks between North and South Korea. However, he has made it clear that his ultimate goal is to force North Korea to relinquish its nuclear program, and says he will walk away from discussions if he gets the sense that diplomatic negotiations wonʼt lead to that end. He has further stated that the United Nations would keep sanctions on until North Korea gives up its nuclear weapons.

Optimism rose last week on unconfirmed reports that the North Korean leader has removed a key obstacle to negotiations with Washington by no longer insisting that American troops be removed from South Korea as a condition for denuclearizing his country. Then on Friday, came a surprise announcement from President Kim that North Korea had achieved its goal of developing nuclear weapons, would be suspending further nuclear or intercontinental ballistic missile tests, and would dismantle the nuclear test site in the northern area of the country.

We are still in the very early days of negotiations, and given several decades of failed agreements, there is no reason to believe this current attempt wonʼt fall apart. However, if they do succeed, de-nuclearization and a peace treaty would be a game-changer for both the North and South Korean economies. It could even pave the path for eventual reunification, although that’s still a far-fetched scenario at this time. IF a reunification was in the cards, South koreaʼs infrastructure, telecom, steelmaking and food companies could be big winners, while defense stocks would be losers

Already, South Korean stocks have been outperforming U.S. equities this past year. Per Nomura, the South Korea nation, with its 50 million people, is undergoing structural changes not only within its giant corporate groups, known as chaebol, but also at the societal level. The KOSPI, which has historically been cheaper than other markets due to corporate governance issues, is set to benefit from this. Currently, the Kospi trades at about 1.1 times book value, compared with 3.3 times for the S&P 500 Index.

Investors can gain exposure to South Korean equities via the South Korea ETF (EWY).

 

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