The Swiss franc is the safe haven of choice today as risk sentiment gets hit from escalating nuclear fears between the US and North Korea. Unsurprisingly, the yen, which is still the second best performer in the G10 FX space, is playing second fiddle to the Swiss franc due to Japan’s proximity to the epicentre in Pyongyang. Interestingly, the Asian indices have fared better than European ones, and US futures suggest that US indices will get hit for a second day when they open later. However, if the US/North Korean tensions continue to escalate then we would look for further Asian stock declines in the coming days.
Watch the Vix
The Vix index has ticked higher, and is back at its highest level since early July. If this situation does escalate then we would expect to see the Vix surge above the May high at 16 when volatility spiked and stocks sold off on the back of fears that Trump could not deliver on his election promises. The threat of a nuclear air strike or even all-out war would be far more serious than May’s stock market sell off, and we would expect the volatility surge to be higher and the stock market sell off to be larger.
Defence companies in focus
Rising geopolitical risks have also driven inflows into gold, and the gold price is 0.6% higher so far today. The boost to the gold price has also benefitted some of the miners on the FTSE 100, with Fresnillo (LON:FRES) and Randgold (LON:RRS) leading the FTSE 100 today. BAE Systems (LON:BAES), the weapons and defence company, has also managed to pick up off recent lows, and is 1.5% higher so far on Wednesday. We would expect US defence companies to also fair well on Wednesday with Lockheed Martin, Boeing (NYSE:BA) and Northrop Grumman (NYSE:NOC) potential gainers from the escalating geopolitical situation with North Korea.
Whether or not this event causes a prolonged downturn in risky assets will depend on the next steps in this crisis. If the rhetoric from both sides continues to ramp up then we would expect the following to asset prices to struggle:
• Global Indices
• Emerging market FX
• Peripheral sovereign debt
• Commodity FX
The asset prices that could perform well if we continue to see an escalation in the rhetoric include:
• Swiss franc (safe haven currency of choice over the yen)
• Gold
• Gold mining stocks
• Defence contractors
• Defensive stocks such as utilities and healthcare
Of course, this could end up being a flash in the pan, so we don’t think that fund managers and traders are going to rush into changing their portfolio allocations just yet, they will want to see how things play out in the coming days. However, if the rhetoric does ramp up, even without actual nuclear follow through, this could spook the market and make it hard for stock indices to rally into late summer due to the fears for global trade and global growth.
Markets on the watch out
The markets are poised for any commentary from the President and Washington regarding North Korea’s threat to attack the US territory of Guam. If we see an escalation of the rhetoric then this sell off could be more than a flash in the pan. A move above 16 in the Vix would be a clear sign that the market is spooked, and it could be pathetic fallacy for risky assets this week.
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