There is no question the North Korea (NK) situation has deteriorated and could very well be headed to a conflict. Outside of an offer of asylum for the Kim Jong Un regime there appear few options. It is clear the current NK leadership is antagonistic and their arsenal now represents a clear and present danger. President Trump has already demonstrated militarily he is not satisfied with appeasement in geopolitical negotiations.
When evaluating the potential impact on U.S. stocks it helps to look at these developments in context to the overall economy and stock market. The economy continues a slow growth path with little threat of a rapidly rising interest rates, which combined represent a constructive environment for the stock market and helps explain its continued upward trend. Corporate earnings are also healthy (Q2 earnings growth for the S&P 500 came in at 10.3% and projected earnings and revenue growth for Q3 are currently around 5%). In addition, any positive developments on a Trump Tax Plan would most likely be viewed as bullish. Taken as a whole, the market is going into this potential conflict in a positive environment.
The last time we experience a conflict like this was the Iraq ground war in March of 2003 (see chart below). You may remember we were just coming out of a nasty recession and the market had started rallying as we moved into the new year. 2003 ended up being a strong year for the stock market. Iraq did not represent a significant global economic component and the market was at the early stages of a recovery.
On the other hand, the 9-11 attack in 2001 hit the U.S. during a contraction in the economy and stock market after the dotcom bust (see chart below). Because of the already weak state of economy and the direct hit to a global financial center, the implications were likely to be longer lasting and more severe.
Investors have to be very careful with defensive moves and a long-term perspective needs to be the dominant factor when making investment decisions. Corrections are often short and markets can bounce back aggressively. That being said, there are numerous periods historically where markets have not only sold off aggressively, they have done so over long period of time (multiple years). Having a strategy in place for this type of environment will be helpful as you start to rely on your investment accounts for income.
The likelihood of a conflict with NK has increased significantly. Kim Jong Un’s threats and acts are unacceptable and he seems unlikely to change his course. NK economic impact globally is very limited and their military capabilities are antiquated. I am not suggesting the possibility for significant damage resulting outside of NK doesn’t exist. Each situation is different and the ICMB and nuclear capability of NK is a game changer, not to mention all their artillery on the DMZ aimed at Seoul.
The biggest issue now may be the U.S. having to calculate whether future ICBM “tests” are actually loaded with a nuke. I won’t be surprised if we start shooting them down.
In summary, normally stocks have responded well to conflicts they believe will be resolved quickly and with little global economic impact when conditions are stable. At present that appears how the market is responding to the NK situation.