US-North Korea summit: symbolism over substance

Thought of the day

by Chief Investment Office 12 Jun 2018

What happened?

US President Donald Trump and North Korean Supreme Leader Kim Jong-un on Tuesday vowed to work toward the “complete denuclearization of the Korean peninsula” at a historic summit in Singapore. A joint statement from the two leaders also included pledges to establish diplomatic relations, seek peace, and for the US to provide security guarantees to North Korea.

The signing of the agreement is in line with our long-held expectations for a diplomatic solution. At a press event, President Trump revealed there would be no reduction in US troops in the region or any immediate easing of economic sanctions. But Trump said that the US would suspend joint military exercises with the South and would invite Kim to the White House “at an appropriate time.”

What next?

Today’s agreement adds to positive political momentum on the Korean peninsula, and President Trump’s optimistic tone suggests a genuine drive to reach a negotiated settlement. Assuming the US follows through on its pledge to suspend joint exercises, we will reduce the probability of further military escalation in the short term to below 10%, from 10–20%, and will keep tracking developments.

But we caution that the statement is likely to be just the start of a long process, with a number of risks and potential sticking points ahead:

  • Strategy: After enduring sanctions and financial hardships in pursuit of its nuclear missile program, North Korea has brought the US to the bargaining table and has gained positive international attention in the process. After this diplomatic success, Kim is likely to be unwilling to denuclearize without significant concessions in return and this could be a protracted process.
  • Credibility: North Korea has a history of making pledges to curtail its nuclear program, only to walk away from those agreements at a later date. Equally, President Trump’s willingness to repudiate past deals, whether on trade with close allies or the nuclear pact with Iran, may add to caution in Pyongyang.
  • Ambiguity: The statement text lacks specifics, both on denuclearization and security guarantees. President Trump’s press conference suggests wider discussions took place than were reflected in the one-page statement. It remains to be seen whether both sides have the political will to fill in the blanks and strike a more concrete deal.

What are the investment implications?

Progress toward a peaceful resolution is welcome, but it is unlikely to have a significant near-term impact on financial markets. Investors appeared relatively unconcerned by the escalation of tensions on the peninsula last year, with North Korean missile tests corresponding with an average single-day decline of just 0.1% in South Korean equities. As such, it is perhaps unsurprising that a reduction in those tensions has so far failed to move markets. Both the KOSPI and the Korean won ended the day flat. This supports our view that there is minimal scope for a rally on any subsequent progress in negotiations.

We remain overweight global equities. While the summit is unlikely to be immediately consequential for markets, the reduction in tail risks related to North Korea's nuclear weapons program could help reduce risk premia over the medium term, and help refocus investor attention on strong earnings and global economic fundamentals.

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