Sabre Rattling Upsets Calm in Markets – Week Ended 8/11/17

As one market commentary this morning put it, the heated rhetoric from both North Korea and the US fell like a rock into the still pool of the markets last week. Tensions escalated between the two countries on Tuesday as Trump tweeted that the US would respond to any actions by N. Korea against the US or its allies with fire and fury like the world has never seen. On that headline, the S&P500 reversed -0.8% from what was an attractive intra-day advance. The bleeding of financial markets continued through Thursday which experienced the most notable drawdown in roughly 3 months. Markets managed to stabilize Friday, but the Dow, S&P, and Nasdaq each declined by -1.1%, -1.4%, and -1.5%, respectively for the week. It was not just domestic equities that sold off; Eurozone banks fell -4.1% and other international also swooned by anywhere between -1% to -2.5% for the week. As might be expected, safe-haven bond yields again moved lower (prices up). Following what has been months of market and investor calm despite ongoing dysfunction in Washington and pro-growth policy (like healthcare or tax reform progress) stagnation, the colorful exchange of words and threats over the use of nuclear force seem to be scary or uncertain enough to reawaken volatility.

From an economic perspective, 2Q earnings season is coming to a close in the US. The year-over-year progress is noteworthy, but should also be at least partially attributed to still-easy year-ago comparisons; looking to 3Q, comparisons should become more challenging. But that aside, corporate earnings and guidance commentary still reflects an economy that is progressing and bolstered by steady consumer and business sentiment. Foreign economies also are showing ongoing improvement. At the same time, while unemployment continues to drift lower, wage growth remains benign to corporate margins meaning that inflation should remain a non-issue in the short-run. That view was supported with the release of the Consumer Price Index last week, which again reflected a pace of inflation that falls-short of central bank expectations and goals. When coupled with the recent escalation of geopolitical tension, it would seem the Fed and other central bankers may be incrementally harder-pressed to move forward with additional rate normalization and tightening efforts despite their idealistic notion to do so.

While the drawdowns experienced last week likely re-awaken markets that have been extraordinarily calm throughout much of the year, it should stand as an important reminder to investors that unexpected developments always have the potential to upset markets in the short-run. They are also a normal part of investing. With that said, it is our understanding from following various experts on the topic of actual war with North Korea (beyond words), the risk may still be overstated. Perhaps more importantly, it is the perspective of experts that the abilities of North Korea to strike the US this year or even the coming few (despite accelerating progress) are even more overstated by the media. This is not to suggest that the prospects of any nuclear attack or not to be evaluated seriously, or that N. Korea isnt moving toward that achievement. Or, that one of the biggest risks in this situation is that each country has a leader that seems to lack the rationality or cool head we might normally expect and from that perspective these worries do have the capacity to increase financial risks in the short-run. We do not believe however that this event materially changes the underlying economic fundamentals of either growth here in the US or globally. But in the very short run (next few months), it is entirely possible and perhaps even probable that volatility continues to rise or at least shift to a higher level than enjoyed by investors YTD because it is our perspective that most investors remain on-alert for anything that looks to have potential of upsetting the Goldilocks environment. Further, we are still within 2% of the all-time highs set by US indexes within recent weeks and hardly constitute a correction. Investors and clients should expect that streak without correction to end at some point, but the important question that must always be considered is whether underlying fundamentals are changing for the worse suggesting that a pullback is the beginning of something more sinister. At present, that answer is no. And, perhaps even more broadly, TINY (There Is No Yield) continues to perpetuate TINA (There Is No Alternative [to stocks] for generating real return).

Posted in Blog Post.