After largely ignoring the flare up between the U.S. and North Korea, markets appeared to have finally acknowledged concern with the situation last Thursday (August 10, 2017) with a 1.5% sell-off in the S&P 500 Index that led to its second-worst week of the year. The sell-off coincided with a series of comments and tweets from President Trump, in which he conveyed direct warnings in response to North Korea’s recent test fire of two intercontinental ballistic missiles, which North Korea claims have the ability to reach U.S. territories. With global financial markets seeming to finally react to heightened tensions between the two nations, some may be wondering whether they should consider doing the same in their portfolios.
Here is where historical context can help. First, our disclaimer: Every event is different, and no one knows with any degree of certainty which crises will escalate and which will be contained. That said, history has repeatedly shown that political and geopolitical crises, after any initial market adjustment, do not typically result in lasting downturns. Rather, geopolitical events have been accompanied by a troubled economy to have a lasting market impact. Looking back at some of the more notable events in recent decades shows that the stock market has generally shrugged them off—recouping losses, if any, within days or weeks (see below chart).
Conflicts that have triggered large declines without a subsequent rebound, such as Iraq’s invasion of Kuwait (1990), tend to be associated with economic weakness; sometimes indirectly. And amid strong corporate earnings and steady economic growth in the U.S., investors appear to be refocusing on the fundamentals as the S&P 500 is already less than one half percent away from recouping all of last Thursday’s sell-off as of the August 14, 2017 market close.
While not being dismissive of the current threat, LPL Research does not foresee a sustained drop in global equity markets barring a military conflict, which we believe is very unlikely at this point. We do not recommend any major changes to asset allocation because of the recent U.S./North Korea developments; however, taking some risk off the table for clients who are overly concerned with the geopolitical risk and want to protect gains probably makes sense given the strong stock market performance in 2017.