Ogre Battle: United States Takes on North Korea … Implications for Stocks

Ogre Battle: United States Takes on North Korea … Implications for Stocks




by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co

Key Points

  • The S&P 500 was hit with a sharp near-1.5% reversal last Thursday, followed by a relief rally.
  • We don't believe significant military escalation is the likely outcome of the battle of wills between President Trump and North Korea’s Kim Jong Un.
  • But it is a year ending in "7" and there are other forces at work which could keep stocks in a choppy pattern for the next couple of months.

Last week, President Trump promised to unleash "fire and fury" on North Korea, which prompted its leader Kim Jong Un to see that bid and raise it to a direct threat against the U.S. territory of Guam. Collectively at Schwab (Schwab Center for Financial Research as well as our experts in Washington, DC) we believe the likelihood of military action remains low.

The best-case scenario is that the situation remains a battle of wills and rhetoric between the two leaders, without significant military action. The worst-case scenario is significant military escalation leading to all-out war; but as noted, we view that probability as presently low.

Geopolitical experts weigh in

I consume quite a bit of research which is generally less available to the investing public; so it's often the case I like to share important tidbits. Gavekal Research is one such firm, and their world-renowned geopolitical experts recently weighed in with their perspective on the North Korean conflict:

"For both North Korea and U.S.-China trade, the realities are simple to state and the conflicts manageable only by patient diplomacy and compromise. Threats of military or economic force are empty bluster, and recognized as such by their targets."

"The only plausible resolution to the North Korea problem is for the United States to find a face-saving way to accept the existence both of the Kim regime and of its nuclear deterrent, in exchange for a credible program to halt further nuclear arms development. This will require cooperation from China, which has a common interest with the United States in a stable Korean peninsula and a freeze on Pyongyang's nuclear ambitions."

Also worth digesting are the views of the geopolitical experts at Eurasia Group (EG), run by my friend Ian Bremmer (with whom I shared some cheer on Nantucket last week). EG believes the probability is growing that the United States and its Asian allies will adopt a policy of "containment and deterrence" toward North Korea’s nuclear program. This could increase long-term friction in U.S.-China relations, which could mean a more elevated level of market volatility in the near-to-medium term.

EG believes the key variable to watch in the next several months is whether President Trump "looks for narrow wins or takes broad aim at China’s industrial policies focused on technological advancement."

Finally, experts at TS Lombard wrote this in their latest note on North Korea:

"Trump and Kim Jong Un are working themselves into positions from which they cannot retreat, and have left China on one side given Beijing's twin desire for denuclearization and regime preservation. After Trump's 'fire and fury' and 'locked and loaded' rhetoric over the past week, it is hard to see how he could stand by and watch fresh missile tests by the North, especially if they fly further into the Pacific."

"…leaves a shouldering crisis that could flare up further at any time if Kim goes too far or if Trump decides the U.S. patience is exhausted and that unilateral military action is needed whatever the consequences."

Reversal(s) of fortune

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