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Market lets off steam as pressure builds between U.S. and North Korea


U.S. equity prices fell broadly on Thursday, August 10, with the S&P 500 Index dropping 1.4 percent and the technology-heavy NASDAQ Index falling by more than 2 percent. Meanwhile, the Chicago Board of Exchange (CBOE) Volatility Index (VIX), which is a measure of market expectations of volatility, surged by more than 44 percent to the highest level since November 2016.

A likely catalyst for the market sell-off was the sharp escalation in rhetoric between the United States and North Korea over that country’s ongoing ballistic missile and nuclear weapons programs. On Tuesday, The Washington Post reported that North Korea had successfully produced a miniaturized nuclear warhead that could fit inside a ballistic missile, based on information from a confidential assessment by the U.S. Defense Intelligence Agency. President Trump then issued a strongly worded statement condemning the North Korean regime and threatening military action. This was followed by Secretary of Defense James Mattis making a similarly sobering threat.

In response, the North Korean military announced that it is preparing a plan to launch four intermediate-range missiles aimed at waters 19-25 miles off the coast of the island of Guam, a U.S. territory in the Pacific Ocean. The missiles would “cross the sky above Japan” before landing in the sea around Guam in “an enveloping strike.” The North Korean military issued a statement about President Trump, stating that “sound dialogue is not possible with such a guy bereft of reason and only absolute force can work on him.”

Increased investor concerns were seen across the global capital markets, with the EURO STOXX 50 Index, representing 50 of the largest publicly traded companies in Europe, falling by 1 percent and the Nikkei 225 futures price pointing to an opening decline of 1.7 percent in the Japanese equity market. Meanwhile, U.S. 10-year Treasury yields fell to 2.2 percent and gold prices rose by 0.7 percent, signifying increased investor demand for perceived safe-haven assets.

Our view

Recent geopolitical events appear to have temporarily shaken investors’ complacency, demonstrated by the ever rising equity prices and ever falling gauges of volatility, or risk. While the “Goldilocks” scenario of both global economic growth and inflation being not too hot, not too cold, but just right for risk assets remains intact, the escalation in rhetoric between the United States and North Korea indicates a major increase in geopolitical tensions and the increased probability of an unexpected outcome.

We do not know what the outcome of the North Korean crisis will be. Our base case is that rhetoric is being escalated by both parties for the twin purposes of galvanizing domestic support and maximizing each country’s bargaining position in advance of future negotiations over nuclear weapons, economic sanctions and possibly diplomatic recognition for North Korea. Secretary of State Rex Tillerson appears to have echoed this view when he told reporters in Guam that “Americans should sleep well at night. I have no concerns about this particular rhetoric over the last few days.”

However, in our view, the risk of a misstep is real, with North Korean artillery positioned within range of Seoul, South Korea, the world’s fourth most populous metropolitan area. The United States appears to have shifted its policy toward North Korea from “soft containment” to increasingly credible threats of military action in order to get the North Korean government to end its nuclear weapons program.

In summary, we believe the global macro-economic backdrop remains conducive for risk assets and we maintain our overweight recommendation on equities relative to fixed income assets. However, we remain vigilant of increasing geopolitical risks in the Korean peninsula and stand ready to adjust our recommendation as events unfold.

U.S. Bancorp is the parent company of U.S. Bank.

This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness.

Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy. Indexes mentioned are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The NASDAQ Composite Index is a market-capitalization weighted average of roughly 5,000 stocks that are electronically traded in the NASDAQ market. The EURO STOXX 50 Index is a market capitalization-weighted stock index of 50 large, blue-chip European companies operating within eurozone nations. The Nikkei 225 Stock Average is a price-weighted index comprised of Japan’s top 225 blue-chip companies on the Tokyo stock exchange. The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) shows the market's expectation of 30-day volatility and is a widely used measure of market risk and is often referred to as the "investor fear gauge."

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