Yet again, North Korean shenanigans worry everyone except for markets. And it proves the point that geopolitics doesn’t matter in an investing framework that is dominated by algorithmic trading. I have come up with numerous analogies to describe this phenomenon, each more trite than the last but I am sticking to a new one which is that algorithms don’t watch CNN. We have stated for months now that the unpredictability / toxicity / incompetence of the Trump administration is irrelevant to financial assets and unless the North Korean conflicts spirals into a military engagement, the belligerence of Kim Jong-un won’t matter either. North Korean tensions will not be the catalyst for a correction in equity / credit markets and while military conflict will cause markets to drop sharply, hedging will be next to impossible. If you are worried about an eventual military conflict, the only choice you have is lower leverage. Short the SPX or Korean equities is tough because of the array of external factors that have driven relentless strength in equities over the past 14 months. Shorting Asian currencies or buy the safe haven yen is also problematic because the ultimate trajectory of global currencies is driven by the direction of the US dollar. Hedging will be a drag that probably won’t help your portfolio because the timing is so uncertain.
Earlier this morning, I spoke with Senior Japan Fellow at the Council on Foreign Relations, Dr. Sheila Smith. She gave a measured, yet alarming assessment of development on the Korean Peninsula and the determination of all member of the UN Security Council, including Russia and China to stem the threat of North Korea obtaining a nuclear arsenal. That said, outside of severe economic pressures, there is little the international community can do. Military options are limited without endangering the populous of Seoul and Kim Jong-un’s domestic legitimacy is intricately linked to his nuclear program. Sheila reiterated what we all fear, that it is difficult to see this current situation not getting significantly worse.
Oh and market’s response: After opening weak, US stocks were unchanged by late morning. Continue to resist the temptation to sell risk assets in the event of an escalation in tension that doesn’t involve direct US military involvement. Geo-politics doesn’t matter until it eventually does. Unfortunately, the outcome is binary. Stocks will head lower in September because of the debt ceiling debate because this is a political scenario that directly effects the bond market. Everything else is noise.