NORTH KOREA

Newsletter
Traditions Wealth Advisors
Christian Roberts/Financial Research Intern
August 17, 2017

 
North Korea’s sabre rattling is causing political and economic concern across the world. The DJIA is down .59% and the S&P 500 is down .93%, and a lot of that is a result of North Korea threatening to attack Guam and Trump’s threats to the isolated dictatorship. The fear is apparent in the stock market, but that fear is probably causing a temporary decline in the market.
            The 7-year old poster above my desk in the office reads at the top “Which will you believe: today’s news or 85 years of performance?” The accompanying chart shows how the stock market has always appreciated in value, even in the wake of recessions from 1926 to 2010.
            The impact of geopolitics on the market are almost impossible to predict. Every situation has different market conditions, but one constant thing connects them, and that is the recovery of the markets. The markets will recover, but the economic conditions dictate how long it takes for that to happen.

            Figure 1, generated from data by Crossing Wall Street, shows how the S&P 500 has responded to significant historical events ranging from market crashes to war, with different reactions for each. Most of these events triggered a sell-off in the markets, which is to be expected with any shock, but what differed dramatically was their recovery.
Shocks to the market, especially when they are geopolitical, do not tend to last very long. The 9/11 attacks took less than two months to return to September 10 levels. JFK’s assassination was not the biggest issue in the market on the day that it occurred, either. The Cuban Missile crisis caused the market to fall only 1% for the week, and it quickly shot up 3.5% when tensions calmed. While these events certainly hurt the market, their impact is usually not as bad as the fear makes it out to be.
The 1973 oil embargo/Nixon resignation, the Cole bombing/September 11 attacks, and Bear Stearns/Lehman Brothers are important outliers to talk about. The United States was in the midst of a recession in 1973 that was caused by the collapse of the Bretton Woods monetary system and 1973 oil embargo. Stagflation (high inflation and unemployment) made the economy even worse, and Nixon’s resignation triggered a sell-off in the market. His resignation came at the tail end of the recession, and less than a year later the economy was recovering.
The inclusion of 9/11 on this list appears contradictory to what I said earlier, but I mentioned these two events because the economy had declined at the 250-day mark after these events happened. That’s because the economy was in a recession after the Dot-com bubble collapse, and the recession occurred before, during, and after these two events. Their 20-day recovery is encouraging, and their 250-day decline should not be discouraging because it was the result of other events not related to the terror attacks.
            The Bear Stearns/Lehman Brothers collapse was a during a sharp decline and sharp recovery period for the economy, and both have negative 250 day returns because they occurred at the beginning of the financial crisis.
These three situations show that the events that took place during these times were not the cause of poor recovery. The poor recovery is the result of other factors. The Dot-com and housing bubbles were disastrous in the 2000s, and any embargo is going to cause economic headaches, but the notable historical events that happened had little impact on the market.
So, what does this mean for the current North Korean situation? The fear of any attack is going to cause more of an impact on the market. In this day and age, we have access to more press and news, so the rhetoric from both sides is seen by everyone. Despite the fear, the chances of a nuclear war with North Korea appear to be very low. An attack on Guam would be suicidal for the regime, and the empty threats can leverage aid for the starving country. There does not seem to be any substance to the fear that the situation is causing. In fact, the Dow’s fall has had more to do with Disney’s disappointing earnings report than North Korea. That’s right, Mickey Mouse is hurting the Dow more than Kim Jong-Un.
 The Cuban Missile Crisis saw 3.5% returns in one week in the wake of the crisis, and the market could react similarly in this case. Warren Buffet took advantage of this in 1963 when the vegetable oil scandal and JFK assassination caused American Express stock to sink, which prompted him to buy 5% of the company for $20 million. That same 5% is now worth almost $1 billion. Bonds can also yield returns. Investors tend to flock towards safe investments like Treasury Bonds and Gold. Gold is approaching its highest price for the year, and Treasury Bonds were up as well. These are safe havens that investors flock to in times of uncertainty, but money could rush out of them once the panic subsides.
Which will you believe: today’s news or 92 years of performance?