How Might North Korea Affect Your Investments?

North Korea. It seems to be on everyone’s mind these days and more than a few people are concerned about where the situation is going. Recently, North Korea has been ramping up their missile tests, and bragging about their nuclear program. What else has been going on with North Korea and what could it potentially mean for your investments? Given the level of client questions and investor concerns, I decided to spend some time on what's going on over there and how different situations could impact your investments in the markets.

North Korea, In Brief

North Korea’s missile muscle flexing and provocative language are making a tense situation on the Korean peninsula worse. The United Nations has slapped extreme sanctions on North Korea that could drastically affect their economy. Much of the current goings on are centered around verbal sparring between President Trump and North Korea. As just one example, North Korea has declared that they are considering an attack on the U.S. territory of Guam and Trump has promised “fire and fury like the world has never seen”^[1] if North Korea threatens the U.S. again.

The recent events have yet to fall into a full bore crisis, but things are tense enough that any further deterioration has the potential to impact the markets. The timing doesn’t help, as we are right in the middle of the August vacation season for Wall Street. This means the main decision makers on Wall Street trading desks could possibly be away at the beach should a political or military event occur between now and Labor Day. While any event in Korea could possibly result in negative volatility for stocks, it could be magnified if some of the primary investment traders are away from their posts between now and then. However, regardless of the timing, stocks would face a higher probability of declining during such a crisis and how markets would ultimately fare would likely depend on the outcome.

Uncertainty And The Markets

Markets hate uncertainty. War or any sort of hostile military action ranks just as high as a financial crisis as the most uncertain type of event investors could face. While we can only guess at how the North Korea situation will play out, here are some possible scenarios and what the market’s reaction could be. Here they are, in order of what I think could likely occur:

1. Status Quo Reigns

The first and most likely scenario is that we stay in a status quo period where nothing of significance happens and North Korea’s provocations are not sufficient to provoke an American military response. If this is where things stay, stocks will probably return to continue taking their cues from domestic economic and political issues.

I've noted in the past that U.S. economic data is currently quite positive and corporate earnings are growing at some of their best rates in years. Also while many worry that the President's economic agenda may have stalled, his Administration is still seen as business-friendly. All of these factors are a positive anchor for stocks. Should this international problem be diffused or put on the back burner, then stocks will continue on a trajectory influenced by these positive elements.

However, stocks have already had quite a run this year and the markets are currently overbought. Stocks could easily enter the summer doldrums and do nothing until later in the year, completely independent of the Korean issue. August through early October are statistically and traditionally weak periods for equities.

2. We Experience a Military Event

Possible situation number two is that things in Korea escalate and military action from the U.S. and our allies is required. Wars or military action tend to historically show two distinct responses from the markets.

First, there is a period of tension as the crisis escalates to the point where military action is provoked.  This has historically resulted in a negative reaction from stocks and a market decline. It is possible that we could experience a 5-20% correction in stocks depending on the severity and length of the crisis. This decline could be swift, similar to what we experienced after the September 11th events, or it could take months to pan out, akin to what occurred after Iraq invaded Kuwait back in 1990.

Second, the markets could experience a violent counter-rally to the upside once the likely outcome of the military action is recognized. In both the 1990 and 2001 events, stocks experienced double-digit rallies after the results of both events became known. This type of response assumes that the military action is short-term with a positive outcome for our side.   Anything that suggests a longer military campaign or the possibility of events leaching out geographically further than North Korea would change this prediction.

3.  North Korea Lashes Out

In this low-probability scenario, North Korea attacks South Korea, an ally, or some territory or part of the United States. The reason it’s unlikely to occur is because these types of actions would sign the death warrant for the North Korean ruling establishment. Regardless of its probability, we should not discount the possibility, however low the likelihood of this sort of event might be. 

Any of these actions would likely be bad for stocks initially. A nuclear attack by North Korea on the U.S. or one of our allies would lead to a really bad day for stocks. There is no way to find the silver lining in the case of such a bombing because the devastation would be biblical and the economic fallout dramatic.  Stocks would likely rally once the results from a non-nuclear, contained attack become known, especially if the loss of life was low and the current North Korean regime was removed.

I want to stress again that the probability of North Korea launching a nuclear missile is low and the probability of them accurately hitting a target would probably be even lower given what we know of their technology and likely military defenses against such an event.  I mention it here only because a low probability does not equate to zero probability.  Our approach to investing means that it is prudent to weigh the results and likelihood of the unthinkable even if we believe the chances of the unthinkable happen are statistically very low.

Control What You Can

Unfortunately, we could make predictions all day long and still have no idea where we will be in the future. There are no tea leaves or magic eight balls that will tell us if this is just more blustering from the North Koreans or something with the potential to become significantly worse. Should this just be more of the same then the market will likely keep focusing on domestic economic issues, the same things we've been looking at for months. Stocks may rise or fall depending on how the market feels about the economy,  but that is different than a sudden military escalation. In short, North Korea could become a major crisis tomorrow or never.

What should investors do? Investors need to be comfortable with their asset allocation and investment positioning. Being comfortable with how you are invested and understanding that a certain amount of volatility is a part of the normal process should help investors ride out any short-term declines that might arise out of a crisis. This is especially true if the crisis is relatively short-lived and ultimately has little economic impact. If you are concerned about your portfolio and how it will fare in the event of a crisis or if you are new to our process and want to set up a game plan for your money, you are welcome to call my office at 708.488.0115 or email us at lumencapital@hotmail.com.

About Chris

Christopher R. English is the President and founder of Lumen Capital Management, LLC-a Registered Investment Advisor regulated by the State of Illinois. A copy of our ADV Part II is available upon request. We manage portfolios for investors, developing customized portfolios that reflect a client’s unique risk/reward parameters.   We also manage a private partnership currently closed to outside investors.   Mr. English has over three decades of experience working with individuals, families, businesses, and foundations. Based in the greater Chicago area, he serves clients throughout Illinois, as well as Florida, Massachusetts, California, Indiana, and other states. To schedule a complimentary portfolio review, contact Chris today by calling 708.488.0115 or emailing him at lumencapital@hotmail.com.

Back early next week.

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^[1] http://www.cnn.com/2017/08/08/politics/north-korea-missile-ready-nuclear-weapons/index.html?adkey=bn