The geopolitical tension between the US and North Korea is not likely to escalate to the point where it causes on the ongoing bull market for equities and other risk assets to crashing to an end, according to Miton’s Anthony Rayner.
Recent months have seen a ramp-up in the spat between US president Donald Trump and North Korean leader Kim Jong-un.
Trump warned about “fire and fury like the world has never seen” if North Korea continues to threaten the US while North Korea has tested its largest-ever nuclear device and fired a missile over Japan.
The events have caused implied equity market volatility – which had been sitting at close to record lows for most of 2017 – to spike and created something of a challenge for the ongoing progress of stocks.
As the chart below shows, the effect has been felt slightly more by the US and South Korean equities, as the two countries are the most closely entwined in the crisis.
Performance of indices over three months
Source: FE Analytics
However, this weekend passed without a potential flashpoint being ignited by North Korea.
The celebrated its 69th founding anniversary on Saturday; while some feared this might be used to embark on more provocative nuclear testing, the country marked the date without any major military display.
That said, North Korea’s foreign ministry issued a statement to the official KCNA news agency on Monday warning the US that it would inflict “the greatest pain and suffering” if the country continues to push for fresh sanctions as punishment for the regime’s nuclear tests.
Rayner, a manager on Miton’s multi-asset fund range, said investors need to look beyond the basic media analysis that centres on “two madmen with nukes” to determine the likely impact that the tension could have on markets.
“There has been a lot of noise, provocations, threats and serious flexing of military muscle between the US and North Korea. Geopolitics is always complex, as it’s essentially horse-trading and brinkmanship on a global scale, but there is an additional layer of complexity here,” Rayner (pictured) said.
“Many of the key actors are relatively inexperienced, which is testing key loyalties (between the US and South Korea, and between China and North Korea) and potentially establishing new alliances, but also probably exacerbating the crisis.
“Donald Trump is relatively new to geopolitics, the South Korean president was elected in May of this year and the North Korean president, who came to power in 2011, is still only 33 years old.
“On the other hand, the Chinese president came to power in 2013 and stands out as much more experienced and statesman-like, though he is somewhat constrained at the moment, ahead of the 19th National Party Congress in October.”
Focusing on Trump, the multi-asset manager said that the US president’s “non-conventional” approach to international relations makes it somewhat difficult for investors to forecast what might happen next in the crisis.
There is an argument that the US has failed to establish itself as a credible military threat to North Korea, as Trump’s threat of “fire and fury” or the promise that the country is “locked and loaded” do not appear to have deterred Kim. Rayner said this type of diplomacy “seems to be exhausted”.
Other “creative, face-saving, diplomatic options” remain possible, he added, including more missile defence systems or further sanctions – which could use the “drastic” option of cutting off oil supplies; however, the effects of these are likely to be slow.
“Our base case is for a second Korean war to be avoided, though clearly some form of military action seems more probable now than a few years ago, and with military exercises increasing, there is the threat of accidentally triggering a war, as well as intentionally. What’s clear is that very few of the key actors want a destabilised North Korea,” Rayner said.
“Importantly for investors, these developments have proved to be market relevant. Markets always struggle to price geopolitical risk, though over recent years central bank liquidity has acted to dampen all risks, including geopolitical,” the manager continued.
“So far, North Korean actions have led to periodic gains for safe haven assets like gold and the Japanese yen, and there’s evidence of South Korean equities and the Korean won hurting.
“However, there is little evidence of a sustained impact in equity markets further afield. Markets are generally fairly resilient and North Korea is unlikely to derail this extended bull market.
Performance of gold vs global equities over 2017
Source: FE Analytics
“In the meantime, we are looking to manage risk, rather than speculate. Part of this is ensuring our investments are diverse and liquid enough to allow flexibility if our base case is challenged, in what might prove to be a fast-changing environment.”