Will North Korea End the Bull Market?

The good times continued to roll in investment markets throughout the third quarter and year-to-date. Below is a report card of various investment categories around the world:

The U.S. stock market continues to reach all-time highs, boosted in part by companies earning record profits. Non-U.S. stocks are also doing phenomenally well. The global economy is experiencing synchronized growth and U.S. household net worth is over 40% higher than the peak in 2007. You’ve likely seen the benefit of rising asset prices reflected on your personal financial statements.

While everyone loves a bull market, we are constantly on the lookout for what might facilitate the end to this one. There’s no shortage of nerve-racking headlines every day, whether it’s horrendous natural disasters, terrorism, a seemingly dysfunctional federal government or saber-rattling between Donald Trump and Kim Jong-un of North Korea. Up until now, the market has largely shrugged off these risks and continued higher. Still, we want to assess these risks, among others, to see if they might be a catalyst for the next recession/market downturn.

This quarterly commentary will look at the North Korea situation and potential impact on investment markets should the rhetoric escalate to a full blown conflict. As you are aware, we’ve seen an increase in tension between the leaders of our country and North Korea in the last couple of months. North Korea has tested intercontinental missiles and continues to poke the “sleeping giant”. President Trump has returned jabs via his infamous Twitter account. It’s no surprise investors are concerned about the prospect of a conflict with a nuclear-armed enemy. While we don’t know what will happen with this situation, we can look back in time at other geopolitical crises and analyze market reactions around those events.

Typically, when news of war and other geopolitical crises hit, markets have an upfront, kneejerk reaction and selloff. Then, as investors have more time to digest and analyze the economic risks, more often than not, stocks recover the decline shortly thereafter. 9/11 is a perfect example of this. Between September 11^th and September 21^st the S&P 500 fell -11.6%. By October 11^th, it had recovered all of the decline. Of course this is just one example, but on average this tends to be the experience.

Why do we see a similar pattern in prior geopolitical crises? I believe the answer is investors are human and we succumb to what Israeli psychologist, Daniel Kahneman, calls our “System 1” thinking. According to Kahneman, System 1 thinking is our quick, emotional, intuitive and reflexive thinking. This is our fear-based, cut-and-run selling when we hear of a geopolitical crisis. This is followed by our “System 2” or slow, deliberate and logical thinking. This is when we actually sit down and evaluate the situation from a fundamental and investment standpoint. Is going to war with Al Qaida, in the 9/11 example, going to cause U.S. companies to earn less money for their shareholders, economic growth to slow, or inflation and interest rates to change materially? Typically the answer is no, which is why the market tends to bounce back.

While geopolitical risks are certainly important and potentially devastating from a humanitarian standpoint, they very often do not translate into changing the direction of the global economy and investment markets over any meaningful timeframe. The ultimate driver of investment returns are economic growth, corporate earnings, inflation, interest rates and valuation (or the price paid). This is why we focus our market indicators on these factors to proactively manage portfolios.

With regard to North Korea, I am no military expert or political scientist, but my personal opinion is Kim Jong-un is looking out for his best interest. I believe he wants to rule for a long time and going to war with the U.S. would likely mean an end to his regime. I also believe China, who has a working relationship with North Korea, has a vested interest in avoiding war and the possibility of a U.S. presence along its southern border. Therefore, I am confident cooler heads will prevail.

Lastly, market corrections, whatever the cause, are normal and healthy. Since 1980, for the years the market has ended with a positive total return, we’ve seen an average -11.5% decline at some point during the year. This year we’ve only seen a 3% decline intra-year, which could be giving investors a false sense of complacency. Our goal is to have clients invested in the portfolio that will allow them to ride out the inevitable, next downturn, and, this is key, before it begins. If you would like to schedule a meeting to discuss your portfolio or if you have any questions, please don’t hesitate to reach out to your Advisor.

Author:
Mike Gallagher and the TPG Investment Committee

This information is provided for general purposes and is subject to change without notice. The information does not represent, warrant or imply that services, strategies or methods of analysis offered can or will predict future results, identify market tops or bottoms or insulate investors from losses. The information has been obtained from sources considered to be reliable, but it is not guaranteed. Past performance is not a guarantee of future results.

Securities and advisory services offered through Geneos Wealth Management, Inc. Member FINRA/SIPC. Advisory Services offered through TPG Financial Advisors, LLC, a Registered Investment Advisory Firm.