Kim Jong Il is among the world’s most reclusive leaders, but he knows how to send a loud calling card.
The latest example came packaged in yesterday’s underground nuclear test, which North Korea announced on Sunday. The political reverberations came quick. “We expect the U.N. Security Council to take immediate actions to respond to this unprovoked act,” White House spokesman Tony Snow said. The new Japanese prime minister, Shinzo Abe, while in South Korea, declared “…that if North Korea’s nuclear test is confirmed, it would be a grave threat not only to Japan and South Korea and neighboring countries, but to international peace and security.”
While the world struggles with what to do next, there’s a report this morning that the chief of South Korea’s intelligence agency told lawmakers on Monday that Kim’s North Korea might unleash a second nuclear test.
As we write this morning, it’s too early to know how the markets will react, but we have our suspicions. Predictably, South Korean stocks dropped on the news while gold and oil prices jumped.
Market reaction, in fact, may continue for days and weeks. For starters, we would expect that when the bond market reopens tomorrow (it’s closed today in the U.S. for the Columbus Day holiday), a burst of fresh demand for the safety of Treasuries will push yields lower once more. Meanwhile, news from the Korean peninsula probably won’t do much to drive up the price of U.S. stocks any time soon.
Volatility, in sum, looks set for a rebound in several asset classes, courtesy of Kim’s big adventure in splitting atoms. It’s likely that the volatility won’t last, however. Mr. Market has become increasingly comfortable in learning to live with heightened risk in the global economy. That’s not to say that a crisis-induced selloff isn’t possible, although it’s less likely these days. Nonetheless, for the long-term strategic investor, volatility is good, even if it’s short-lived. The reason: volatility can deliver some temporary bargains.
Indeed, history shows that when the world gets nervous, spreads widen and riskier assets are disposed of with haste. It’s too early to say if a similar scenario awaits this time around, but we’ll be watching in case fresh opportunity avails itself. Cash is burning a hole in our pocket, as it has been for some time now. But while we’re not ready to part with a heavy overweight in the asset class just yet, we’re mindful that at some point a substantial rebalancing is necessary to fend off the performance drag that cash invariably delivers over time. Timing, of course, is the great variable that weighs on our decision, and that in turn will be driven by valuations, trailing returns and a number of other variables.
But let’s not minimize the challenge of finding value. As the table below reminds, screaming buys are an endangered species. Everything has rallied to one degree or another, and so nothing looks particularly compelling. Take note that negative returns are listed in red, and on that front there are only two instances, and both are in commodities, and both are of recent vintage. Of course, given today’s news, along with reports of OPEC’s efforts to reverse the drop in oil prices of late by paring output, the commodities-related red ink may soon turn black once again.
In which case, where will red numbers be most likely to appear next on our table? Inquiring, opportunistic and strategic-minded investors want to know.

One thought on “HE’S B-A-A-A-C-K

  1. kharris

    As to the market reaction to North Korea’s nuke test, well, it was a bit perverse, but not all that surprising. The biggest lift to 10s in response to a nuke test was decades ago, when India popped its first. Ten basis points was about all it was good for. More recently, reactions have been even smaller. Nuke tests have not, as a rule, bred large responses in the bond market. Since this one was well telegraphed, one would expect much of the reaction already to have taken place. Friday, Treasuries got a whuppin’, so no big reaction to the test then, either. Positions and prices matter. We came into this quarter expensive, and long.

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