UBS House View Daily

Thought of the day

11.08 - Mushrooming rhetoric

Risk assets extended their sell-off on 11 August after President Trump said his “fire and fury” statement “wasn’t tough enough.” The VIX jumped to 16.17, its highest level since the US elections last November. The S&P 500 closed 1.4% lower, its biggest oneday drop since 17 May, while the three-day decline in the KOSPI reached 3.13%.

But, while a severe military escalation remains a key tail risk, we see several reasons why current US-North Korea tensions are unlikely to derail global markets:

  • The VIX remains well below its historical average of 19.54. The current spike is of similar magnitude to the one that preceded the French elections, and smaller than the surge to 21.48 following Trump’s surprise election victory. Previous episodes of volatility have generally proved short-lived and typically give way to periods of low volatility.
  • The US is still pursuing a diplomatic approach to North Korea. This month, the UN Security Council tightened sanctions against North Korea, winning approval from both China and Russia. If sanctions succeed in slowing the flow of money and technology into North Korea, equity markets are less likely to face disruption.
  • The global economic backdrop remains positive, with monetary policy still supportive and inflation tame. Global GDP growth and corporate results are solid, with US and Eurozone earnings per share on track to rise by around 10% for the second quarter.

Therefore, we see no reason to flee risky assets at this point, and remain overweight global equities. Individual investors with large exposure to assets that could suffer disproportionately in the event of a military escalation should consider diversifying and/or hedging strategies.

Chart of the day

Previous spikes in the VIX have been short-lived, giving way to periods of low volatility

Mushrooming rhetoric

Source: UBS, Thomson Reuters, as of 11 August 2017

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