Traders can be a little sluggish during the dog days of summer, but it took the threat of nuclear war to wake markets up this week.
Global equity markets slipped from record highs after US president Donald Trump and North Korean leader Kim Jong-un traded threats on Wednesday, with the latter threatening to fire nuclear missiles at a US military base on Guam, and the former saying America would respond with ‘fire and fury’.
Asian markets, in particular South Korea’s Kospi, dipped on Wednesday and continued to fall on Thursday after a slight bounce in the morning. However, given the headlines on both sides of the Pacific hyping the prospect of imminent Armageddon, the fall was remarkably restrained – the Kospi actually fell more on July 28, during a global rout in technology stocks, than it did on Thursday.
‘These kind of political disruptions tend not to have a lasting impact on the market,’ said Daniel Morris, senior investment strategist at BNP Paribas Asset Management. Negotiations between the US and North Korea remain the most likely outcome, he said, and investors have generally come to accept that what Trump says is not necessarily what the US does.
‘Except this situation does feel a little bit different. It’s a more challenging problem, with a greater potential for bad outcomes,’ Morris said.
Even so, unless there is a substantial escalation, markets are likely to remain relatively sanguine about the risk of war.
‘I think markets would take [another missile launch] as a pretty negative sign. I think you would see a significant risk-off move in that case, because it’s intentionally more provocative. I think that’s the next thing that investors are going to look for,’ Morris said.
All summer, markets have shrugged off the aftershocks of the European debt crisis currently shaking Southern Europe, a less-than-stellar US economic outlook and the coming end of quantitative easing. In Asia, markets have been sanguine about a slowing, highly-indebted Chinese economy and a fractious political backdrop.
Asia ex-Japan equity funds passed their 20th consecutive week of net inflows last week, their third-longest ever winning streak, according to UBS. EPFR Global data, cited by UBS, shows that investors pumped $1.6 billion into Asia ex-Japan vehicles last week, with 62% going into Korean markets – albeit before the latest escalation in tensions between the US and North Korea.
Asian funds have experienced longer streaks only twice before, between May and December 2010, and September 2012 to February 2013.
MSCI’s Asia ex-Japan index is up more than 29% year-to-date, driven in large part by surging tech stocks. The global emerging markets index is up 24%. Before Pyongyang’s threat to strike at Guam, South Korea’s Kospi was up 18% for the year.
Investors, including private banks in Asia, have been bullish on the continued prospects for Asia funds. In their half-year outlooks, DBS, UBS and UBP, along with several major asset managers, said that they remained positive, despite some rumblings that a correction was looming over the ‘summer doldrums.’
Measures of volatility have been at historical lows, prompting concerns that markets were sleepwalking. As Cesar Perez Ruiz, chief investment officer at Pictet Wealth Management, wrote in a note earlier this week: “Against a backdrop of not-inconsiderable risk, it seems that complacency is creeping in.”
That may have changed. The CBOE Volatility index rose more than 40% on Thursday, as the US markets started to flicker with worry.
Safe haven assets, including gold, have risen in line with worries about Armageddon, but as Old Mutual fund manager Ned Naylor-Leyland, who oversees the firm’s gold and silver fund, said in a note on Thursday, institutional holdings of gold are at a historically low level. The metal ticked up past $1,281 on Thursday.
‘Gold, of course, is already a core asset class for central banks, the super-rich and what are classified as “the global poor”. Should the North Korea situation develop it may just prove to be the catalyst to push the institutional world to commit flows back to this asset class on a sustained basis,’ Naylor-Leyland said.