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War Of Words Around North Korea Rattles Investors

Tom Burroughes, Group Editor , 10 August 2017

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Escalating tensions around the weapons programme of North Korea have hit markets. Financial professionals and analysts comment on the situation.

Markets were roiled yesterday by further signs of escalating tensions between North Korea and the US. 

US President Donald Trump has cranked up the rhetoric against the hard-line Communist state; he has promised to inflict “fire and fury” on the country if it threatens the US. In turn, the totalitarian state has threatened a missile attack on the US Pacific territory of Guam. At the core of the issue is North Korea’s alleged attempt to build nuclear weapons that can be fired at the US and neighbours.

Trump’s subsequent boasts about the size of the US nuclear arsenal – hedged with his desire not to have to ever use it – have also added to a tense atmosphere. Unsurprisingly, so-called safe haven assets such as the Swiss franc, gold and US Treasuries have gained. On the flipside, US and other major developed nations’ equity markets have weakened. In morning trade yesterday, the S&P 500 Index of US stocks fell by 0.4 per cent, the largest fall in almost five weeks. 

While investors may already have reasons to pull back on markets such as US stocks, having been in a bull run for more than nine years and at relatively high valuations in historical terms, the Korea situation has been a catalyst for further selling. And when investors fully return to work from the annual vacation season, autumn – often known as a volatile time of the year for equities – could see further selling. 

“US President Donald Trump’s citing of unprecedented ‘fire and fury’ in response to any threat to the US, and the subsequent North Korean reference to contingency planning for a missile strike on Guam,  make a negotiated settlement more problematic,” Alison Evans, deputy head of Asia Pacific Country Risk, IHS Markit, said in a note yesterday. 

“North Korea is likely to continue testing and advancing its weapons capabilities undeterred by US pressure or UN sanctions. Even a limited pre-emptive military strike by the US or its allies would be almost certain to draw a retaliation by North Korea, risking a nuclear conflict,” Evans continued. 

Her colleague, Karl Dewey, CBRN Analyst, Jane’s by IHS Markit, added: “Brinkmanship is highly psychological and the potential for miscalculation is high, particularly as so little is known about North Korea’s true preferences and threat perceptions.  If this rhetoric continues both sides may find themselves trapped into a conducting a military response that could be devastating for the region. For North Korea, the threat against Guam is very specific and sets a bar to be measured against. Not following through could be seen as a lack of resolve.”

“The ability to hit the US mainland is part of Pyongyang’s efforts ensure the US and its allies do not embark on a programme of regime change. Despite the apparent success of its ICBM programme and ability to mount nuclear weapons onto its missiles, there is still debate over whether the North’s re-entry vehicles (RVs) are capable of surviving re-entry, as the 28 July Hwasong-14 (KN-20) test appears to have disintegrated upon re-entering the atmosphere. Nevertheless, there could be a number of reasons for the debris seen in the footage, including the burn up of second stage, or that the additional pressures on the RV created by the lofted trajectory caused a breakup, but the RV may still be viable for a normal trajectory,” he said. 

“In May 2016, after analysing the video of the KN-08 and mock-up of the nuclear warhead, Jane’s by IHS Markit assessed, with reasonable confidence, that the RV for that missile was viable and would survive re-entry. Even if the North is experiencing difficulties with its RVs, it appears that it will only be a matter of time before they achieve this and can hit the US,” Dewey continued. 

As far as the investment calculus is concerned, Amundi, the European wealth management house (€1.121 trillion as at the end of June this year), struck a relatively sanguine tone. “Equity markets (including Korea) have tended to react less and less to this posturing (the Korea Composite Stock Price Index was only down 1% last night). If the rhetoric looks like it might lead to something, then we would expect some shifting of allocations in portfolios.  But overall, we don’t think long only investors will pay too much attention in the short term with the focus being more from shorter term traders,” Nick Melhuish, Head of Global Equities at Amundi, said in a note.

“Any really large sell-off in Korean or regional risk assets would be perceived as a buying opportunity but we are a long way from that point with a muted market response so far. It would be beneficial generally to see this escalating problem resolved and China will be key to this. It will be important to wait for China’s reaction the latest developments,” he said. 

“The main concern here would be that this acts a negative catalyst for US equities. It could converge for example with the Russian probe and lead to a bout of risk off market behaviour. Equities as a whole would be impacted by this, and it isn’t necessarily the case that Asian markets would be the most impacted,” Melhuish added. 

Dewey, meanwhile, added: “From the North Korean perspective all sanctions are part of a programme of isolation and regime change.  They argue that talks on nuclear disarmament need to be seen in a global context, and not about their programme in particular. The US insistence on a stopping of nuclear activity as a pre-condition for talks are seen by some in the US as a way of preventing the reward for ‘bad behaviour’, but this position is counter-productive and ignores the North’s perspective that this is a pillar of its survival. There are also practical complications in verifying that the North has stopped its nuclear and missile activities. North Korea will likely better respond to calls for talks when such terms are dropped and, from their perspective, talks are based on equal terms.”

 

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