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November 30, 2017

Should Investors Worry About North Korea’s Missile Tests?


By James Picerno, The Capital Speculator

North Korea on Wednesday announced that it had launched another missile to test its nuclear-strike capability, which reportedly can now reach the United States. Should we be concerned? Yes, of course. For obvious reasons, every citizen of Planet Earth should be alarmed when a war-mongering government threatens to use nuclear weapons. But as investors, Kim Jong Un’s provocations should be treated as noise.

In fact, the US stock market seems to be increasingly immune to North Korea’s ongoing military exercises. In 2016 and 2017 (excluding the latest launch) , the rogue regime successfully tested missiles 15 times and conducted three nuclear tests, according to Wikipedia. The initial reaction of the S&P 500 to those events over that span has evolved from sharp declines to a collective yawn, based on the subsequent five-day price changes following the dates of launches and/or tests (see chart below). It’s too soon to know how the S&P will respond to the latest event over a five-day period, but yesterday’s pop in equities suggests that investors aren’t panicking.



To be fair, it’s impossible to identify the market’s changes in history in connection with North Korea’s military actions. Stock prices rise and fall for numerous reasons on any given day and so it’s guesswork at best to link short-term market shifts to any one event. But one thing seems clear in the chart above: the crowd appears to be increasingly reluctant to sell equities simply because Pyongyang decides to engage in another round of saber rattling.

That could change, or course. The next event could draw a darker reaction, perhaps because a missile lands closer to Japan or the US. But for the moment, the history over the past couple of years suggests that Mr. Market is looking past North Korea’s crude efforts to draw the world’s attention to its menacing behavior.

Is ignoring news reports for what could be a prelude to a nuclear war rational? Perhaps, or so one could argue, at least from an investment perspective. If, in fact, the worst-case scenario unfolds, there may be no place to hide, in which case steep losses in your portfolio may be the least of our worries.

But let’s say you’re inclined to build a defensive asset allocation that, in theory, offers the prospect of stability during a nuclear exchange between the US and North Korea. What assets look attractive in that scenario? Treasuries? Gold? Burying cash in a concrete box in your backyard? Selling your stocks today to build a stockpile of freeze-dried food for the coming nuclear winter?

If you have to make a bet of probable outcomes there’s a persuasive case for assuming that whatever happens the US will prevail. The price tag could be horrific, but when the nuclear dust clears it’s virtually certain which country will survive and which one won’t. To the extent that a semblance of business as usual returns at some point, which it probably will, markets will recover and economic activity will resume. It could be (probably will be) ugly in some respects – high numbers of casualties, radiation poisoning, whole cities rendered uninhabitable, and a general sense of dread for years to come. Not exactly the raw material for optimism and bull markets.

But if there’s a morning after, it seems reasonable to assume that life will go on. Planning for an alternative scenario that reflects a far darker outcome may be practical in terms of factoring in the full range possibilities. But as money management strategies go, I have no interest in preparing for the worst by way of asset allocation. The decision is effectively a choice to forgo trying to optimize portfolio results for a nuclear apocalypse and instead betting that the global economy (or most of it) will survive.

If I’m wrong, so what? I probably won’t be focusing on the finer points of rebalancing and credit spreads. If I’m right, and I probably will be, life will go on and risk premia will, at some point, rebound. All the more so if North Korea’s actions turn out to be little more than bluster, which is the basis for my thinking. Kim Jong Un is a tyrannical provocateur, but he’s almost certainly not suicidal.

About the Author - James Picerno is a veteran financial journalist since the early 1990s at Bloomberg, Dow Jones, etc. before becoming an independent writer/analyst/consultant in 2008. James is also the author of Dynamic Asset Allocation (Bloomberg Financial, 2010) and he writes at The Capital Speculator(Author Archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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