North Korea summit doubts aren’t a risk-off event

Thought of the day

by Chief Investment Office 25 May 2018

President Trump’s cancelation of a planned summit with North Korea, citing the North’s “tremendous anger and open hostility,” sent a brief shiver through risk assets late on Thursday and on Friday morning. The S&P 500 and the KOSPI indexes dropped almost 1% intra-session after the news, before paring losses into their respective closes.

But we don’t view disarray ahead of the unprecedented US-North Korea summit as a significant risk signal:

  • Asian markets are hardened to North Korea risk. The previous seven nuclear tests led to an average decline of just 2% for South Korean equities. Following the summit news, the KOSPI closed down just 0.2%, while the safe-haven yen actually declined.
  • The cancelation aligns with Trump’s trade negotiation playbook – swinging between a hard line and sweeteners to force a favorable outcome. The sides remain engaged in diplomacy: Trump’s letter invited Kim to call him, while the North pledged to talk anytime, anywhere. Both leaders would benefit from a summit, with Trump notching a win ahead of mid-term elections, and Kim potentially earning sanctions relief.
  • The alternative, a rushed or failed summit, would be a far worse risk outcome for investors. Barring agreement on the scope and timetable for denuclearization and sanctions relief, the risks of military escalation could rise.

So we view Trump’s summit cancelation as more of a negotiation tactic than a significant decline in the diplomatic process, and see a low probability of military escalation (10–20%). The broader market risk is to US-China relations. If Beijing is blamed for undermining the summit, as Trump has hinted, we may see a harder line in trade negotiations. We remain risk-on in the region, with a preference for China equities within our Asia portfolios.

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