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North Korea's threats fail to rattle markets

Anthony Fensom  |  03 May 2017Text size  Decrease  Increase  |  

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Providing tensions ease on the Korean peninsula, investors who are appropriately positioned may witness a bullish year ahead for Asian equities.


North Korea has threatened nuclear war against Australia and other US allies, amid a growing geopolitical crisis on the Korean Peninsula.

Yet with financial markets remaining relatively calm, should investors take preventative measures or tune out the escalating rhetoric?

On Saturday, the Stalinist state ignored threats of further international sanctions by test-firing a ballistic missile, its sixth test this year.

While the launch appeared to have failed, it followed warnings from neighbouring South Korea, Japan, and the United States against further provocations by Pyongyang that could lead to "catastrophic consequences".

"The threat of a nuclear attack on Seoul, or Tokyo, is real, and it's only a matter of time before North Korea develops the capability to strike the US mainland," US Secretary of State Rex Tillerson warned.

North Korea has threatened Australia against "blindly and zealously toeing the US line," stating that Canberra's support of US efforts to isolate the hard-line state would be "a suicidal act of coming within the range of the nuclear strike of the strategic force of North Korea".

Nevertheless, financial markets in Asia and Australia appear to have downplayed the risk of renewed hostilities on the Korean Peninsula.

Asian markets outside of Japan posted their fourth straight monthly rise in April, while Japanese stocks have recently rebounded to hit their highest level since March.

On 1 May, both Japan's benchmark Nikkei Stock Average and China's Shanghai Composite Index were showing around a 1 per cent gain this year, while South Korea's Kospi Index was up by an even healthier 8.8 per cent.

The Japanese yen, which often rallies during a crisis due to its "safe-haven" status, was trading at its weakest level since the end of March.

The South Korean won, which is most exposed to market sentiment, has also recovered much of its previous losses, with traders appearing more concerned about trade ties with the United States and the South Korean presidential poll.

"If you look at the reaction from the financial markets, the consensus is that nothing major will happen. We did see some impacts on US bond yields when the US aircraft carrier [USS Carl Vinson] was deployed, but it wasn't very significant," said Griffith University's Suman Neupane, a senior lecturer in finance in the Griffith Business School.

"US equities and Australian equities have continued going higher--investors don't seem very worried at this point in time."

According to Neupane, the "devastating" consequences of war make it more likely that the major players in the crisis will come to the negotiating table.

He pointed to other geopolitical risks, including Brexit, the French presidential poll, and other European elections, as being equally worrying for investors, along with the Chinese economy and rising US interest rates.

Economic damage

Should the crisis worsen, however, the Japanese yen is likely to strengthen against the won, with any surge in risk aversion likely sending the yen higher overall and Japanese stocks lower.

South Korea's corporate sector has already suffered damage, with China having imposed economic sanctions on Korean businesses in response to Seoul's installation of a US missile defence system, THAAD.

According to Credit Suisse, China's moves to restrict tourism to South Korea and block imports of Korean cosmetics and other goods could cut 20 per cent off South Korea's economic growth in 2017, with such actions also hitting South Korean consumer stocks.

China could also suffer though, with US President Donald Trump reportedly having told Chinese President Xi Jinping that sanctions against North Korea could include penalties against Chinese banks and companies doing business with the regime.

North Korea currently conducts almost 90 per cent of its trade with China, including exports of coal, iron ore, seafood, and textiles.

Investor positioning

"If the crisis plays out longer, there may be a significant increase in demand for safe-haven assets such as the Japanese yen, US Treasuries, and gold," Neupane said.

He suggested Australian investors worried about the crisis could consider going "underweight" higher-risk assets such as equities and "overweight" the lower-risk assets.

"Yet the Australian market is very dependent on what happens in Asia--I don't think anything would be immune to the risk," he said.

"It could also be a temporary opportunity, as we saw during Brexit or the early stages of Trump gaining power, when markets tumbled and then recovered their losses."

Nikko Asset Management's senior portfolio manager, multi-asset, Robert Samson, suggests the immediate likely impact of a flare-up would be a "shock to currencies across Asia, particularly the Korean won, whereas the Japanese yen would strengthen ... and the knee-jerk reaction would be to sell equities".

"Bonds would be more resilient, as the deflationary shock would compress yields, while US Treasuries and JGBs [Japanese government bonds] would rally," he said.

However, providing tensions ease, Singapore-based Samson still sees a bullish year ahead for Asian equities.

"Global demand and trade has been in a steady recovery since 2016, and with that reflation too, which has lifted purchasing prices and profits for Chinese industrial companies in particular," he said.

"These profits are then flowing through to wages and increased consumption, so the Asia story is quite strong, with attractive valuations and an improving earnings outlook as the growth story continues.

"If there is a shock, there's a good chance that things will be worked through and of course you'll get the market rebound that follows.

"It's just like trying to stay out of Europe in anticipation of the French elections--French equities have actually risen with the latest poll results, so you just need to make sure you have a diversified portfolio with not all your eggs in one basket."

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Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

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