11 Aug 2017 What would happen to global financial markets if . . .?

Markets have, on the whole, been surprisingly resilient during the latest round of escalating rhetoric between Kim Jong Un and President Donald Trump, following Un’s successful long-distance ICBM launches, threats of attack on US Territory Guam, and surprising new intelligence assessments that he now has the ability to top his ICBMs with nuclear warheads. While it has long been understood by the international community that North Korea holds South Korea hostage under its guns to preserve its repulsive regime, Un’s recent belligerence, joined by his newly acquired abilities, have brought the decades-long stand-off to an unacceptable impasse for the US, South Korea, Japan, China, the region and the world.

Korea has been in turmoil for the better part of the 20th century. In 1910, it was annexed by the Empire of Japan. After WWII the country was divided into two zones along the 38th parallel by the United States and the Soviet Union. The Soviets occupied the north and the Americans the south. Negotiations on reunification failed, and in 1948, separate governments were formed: the socialist Democratic People’s Republic of Korea in the north, and the capitalist Republic of Korea in the south. The Korean War broke out in 1950 when the North Korea invaded the south and ended in 1953 with a ceasefire under the Korean Armistice, but no peace treaty was signed.

Since then, under the totalitarian dictatorship of the Kim family (Kim il sung ’48-’94, followed by his son, Kim Jong-il ’94-2011, and his son Kim Jong-un 2011-present), the North has increasingly added to their conventional defenses and hostage-grip on South Korea. Unfortunately, that grip has enabled the North, subsisting under continual international and US sanctions as well as steady diplomatic and military threats by three US presidents before President Trump, to reach their ambitions of having and ultimately being able to land nuclear weapons anywhere in the world they desire. They are now much closer to realizing their aims than anyone expected despite threats and sanctions.

Kim Jong-un, like his father and grandfather before him, see the present course as the only way to ensure the continuation of his regime. It has worked, even while the country obtained nuclear capability, because no one, specifically no American president, wanted to be responsible for causing the death of hundreds of thousands of innocents, if there is any chance at all of diplomacy working.

In the past China has had little interest in helping the US because it has largely not been in their own self-interest. The latest set of UN sanctions, while historically significant in that there was unanimous agreement, including China and Russia, are still half-hearted on China’s part because they cannot afford to sufficiently destabilize Un’s regime to the point of internal chaos. That eventuality would open the possibility of significant threats on their southern border including a mass migration of refugees into China and ultimately, the possibility of a unified Korean Peninsula, under Seoul’s and US influence that they could not tolerate.

North Korea, under Kim Jong-un’s relentless pursuit of tactical and strategic nuclear capability is so close to a reality that the world is now uniting against him in a way we have never seen, but still largely in diplomatic terms. A closer look at why military actions have been avoided by so many for so long is helpful.

It is said that there are some 21,000 pieces of artillery, rockets and missiles stored in mountain caves near the southern border of North Korea that can quickly be readied to begin firing on South Korea. At the first sign of attack, or in defense of counter-attack, the North would likely unleash a barrage of conventional explosive fury on the city of Seoul, just 35 miles south of the border, killing potentially hundreds of thousands of civilians in a matter of hours.

US, Japanese, and South Korean warplanes, accompanied by tomahawk missiles launched from naval warships and subs would quickly diminish and eventually eliminate the North’s mountain-based batteries and halt or turn-back the advance of ground forces. While these efforts were underway, the North’s known nuclear launch command and sites, along with production capabilities would be destroyed. But whether the US attacked preemptively, or in response to a hostile act by the North, Seoul, the world’s 11th largest city of 25 million people, would pay the highest price to stop Kim Jong-un. That is, of course, unless Un already has the capability to deliver nuclear weapons to Japan or to the US mainland.

What would happen to global capital markets if a nuclear weapon were to hit one or more American cities?

It’s fair to say, that with today’s speed and reach of information, a nuclear explosion in an American city would set off a level of panic we have never experienced, so assessing the degree of market damage is tenuous at best.

When the Japanese bombed Pearl Harbor on Sunday, November 7th, 1941 it would be hours, if not days before all Americans knew of it. Most of the images conveying the story were still prints in newspapers. The newsreels showing the gruesome truth on the large screens of local movie houses came days later, after folks had come to grips with the initial shock. Stocks fell 4.4% on Monday and 3.2% on Tuesday before stabilizing. Building the war machine required to take on the Japanese and ultimately the Germans, would be great for business and jobs. The Great Depression would end with a revival of the US economy unlike any before.

When the US was attacked on Tuesday morning, September 11, 2001, the New York Stock Exchange and the Nasdaq did not open for trading. Officials elected to keep the exchanges closed until September 17, the longest shutdown since 1933. As a practical matter, many trading, brokerage, and banks had offices in the World Trade Center and were not able to operate following the destruction of the twin towers.

On the first day of NYSE trading after 9/11, the market fell 7.1% decline, setting a record for the biggest loss in exchange history for one trading day. As recorded in Investopedia, “at the close of trading that Friday, ending a week that saw the biggest losses in NYSE history, the Dow Jones was down almost 1,370 points, representing a loss of over 14%. The Standard and Poor’s (S&P) index lost 11.6%. An estimated $1.4 trillion in value was lost in those five days of trading.”

As history reveals, if an American city or cities, were to be struck by nuclear weapons, stock, bond, and commodity market trading would be halted immediately for a sufficient time to allow panic to subside and for the dissemination of news regarding the likelihood of continuing threats, the extent of damage to life and property, and for the sharing of managements’, analysts’, and economists’ assessments as to the damage caused to people, resources, confidence, and the overall economy.

Given that our markets have experienced significant shocks before only to rise to new heights in the aftermath, it is impossible to gauge depth of decline possible. But we do have some precedents to guide us. The financial meltdown following the financial crash of 2007 saw stocks fall between 50 and 58% before coming back. This and the Great Depression are the two worst systemic catastrophes in US market history. The damage was broad enough, touching sufficiently all of the economy so that recovery would be measured in decades.

A nuclear event is local in its physical and human destruction, but general in its ability to scar our emotions and confidence. It is hard to know how we and the world would react to such an event. But if Pearl Harbor and 9/11 are any guides, the American spirit would not be quenched. If anything it would galvanize a united and strong resolve to recover and ideally, to bring global pressure to bear on the world’s nuclear powers to reign in an unbridled race toward nuclearization by too many unsteady militant states.

If you’re a Beacon client, please remember that your portfolio is designed to withstand significant shocks. All of our models performed very well during the ’07-’08 crisis, significantly better than popular alternatives.

This current uncertainty is a good reminder to take no more risk than is required to meet every goal you value, to continually refine your your goals, to work your financial plan, and enjoy the life you have.

As always, feel free to call, email or stop by with your questions.