The announcement of the British Snap election by Prime Minister Theresa May looked like a smart move in April, as it was a good way to stabilize the Conservative Party’s power following a stormy Brexit campaign, and the aftermath of the shocking referendum itself. Financial markets welcomed the announcement, as British stocks rallied after an initial spike lower and remained strong ever since.
The performance of the FTSE 100 Index since the announcement
The latest opinion polling trends
Now, with only a couple of nights before the election, things aren’t looking so good for the ruling party, as the polls are getting very close, with the Labour gaining ground across the board, even after the terror attacks in Manchester and London. The rally in the Pound stalled at 1.30 against the USD, and the Euro has been steadily gaining ground on the currency amid the growing uncertainty regarding the results.
The performance of the EUR/GBP pair Index since the announcement
With some of the polls now in the “too-close-to-call” territory, there is a slight chance of the Torys even losing the election, but that would still be a huge surprise. The real question is whether or not the conservative party will have the majority after the referendum.
The Possible Effects
Traditional safe-haven assets like gold and the Yen are rallying before the election, but that also has to do with other global events, not solely the British developments. That said, a slight dip in those assets is expected in the case of a Tory majority, while a hung parliament or a Labour victory would likely cause a sell-off in risk assets globally and especially in the UK, with the Pound and stocks being negatively affected. While it looks unlikely that any result would turn around the Brexit process, markets usually fall on uncertainty.
As of now, prediction markets give around 75% chance for a Conservative majority, but as it happened in the case of the Brexit vote, polls might be misleading and the last-minute trends could lead to huge surprises. With 650 seats up for grabs at the election, the party would need 326 (currently holding 330) to retain its majority.
Stay tuned for more updates as we get closer to the results of the referendum!
It’s Decision Day for Catalonia’s President
Catalonia’s President Carles Puigdemont has until 10:00 (08:00 GMT) Monday to clarify to the Spanish government whether or not he has declared independence. Depending on the decision, Spanish Prime Minister Mariano Rajyo is prepared to begin the process of ousting the leader of the autonomous Catalonia community.
Running Out of Options
Puigdemont quickly declared independence after Catalonia’s landslide referendum on Oct. 1, where 92% of voters backed independence. However, he later suspended secession from taking effect at a regional parliament session last week. Puigdemont now finds himself between a rock and a hard place, with both the government in Madrid and separatists upset and confused by his tactics.
For Puigdemont, the decision isn’t so simple. For starters, dozens of Catalan companies have announced they would move elsewhere in the country rather than face the legal hurdles of independence. Catalonia is one of Spain’s most prosperous regions, with a local economy worth $250 billion.
He has previously stated his government is “against aggression and against imposed rule.” Those comments put the Catalan leader no closer to clarifying his position.
The Spanish government has repeatedly said it will not accept Catalan separatism and has, for the first time, invoked Article 155 of the constitution. This provides Madrid the leverage to suspend regional autonomy and impose direct rule.
According to Bloomberg Politics, Catalonia was a major talking point for investors on the sidelines of the International Monetary Fund (IMF) summit in Washington this weekend. The autonomous region’s 2020 bonds rose last week, driving the yield down sharply.
On Sunday, Puigdemont attended a commemoration in Barcelona in recognition of a Catalan leader who was executed during the Civil War.
Spain is one of the 19 countries that share the euro. Secession would likely undermine the single currency project and drive the euro lower against other major currencies.
Featured image courtesy of Shutterstock
North Korea Just Fired Its Second Missile Over Japan, and Investors Don’t Seem to Care
Investors are getting less excited by North Korea’s antics. The Communist state just launched its second missile over Japan in as many months, and Asian markets are shrugging it off.
North Korea Taunts Japan with Second Missile Strike
It didn’t take long for North Korea to vent its frustration after the U.N. approved fresh sanctions targeting the hermit state. Pyongyang apparently launched a missile at 6:57 a.m. Friday that flew over the northern island of Hokkaido, according to a Japanese government spokesman. The missile landed some 2,200 km away in the Pacific Ocean.
The North Koreans launched a similar test last month in a show of defiance following a verbal war with U.S. President Donald Trump. The latest provocation comes days after the U.N. Security Council targeted Pyongyang with fresh sanctions over its aggressive nuclear program.
The sanctions were part of a U.S.-drafted resolution that intends to do the following:
- Limit North Korea’s oil imports
- Ban its textile exports
- End additional laborer contracts held overseas
- Reduce smuggling efforts
- Prevent Pyongyang from entering joint ventures with other nations
- Sanction government entities
North Korea saber-rattling has been a major source of volatility in the financial markets, but that appears to be changing. On Friday, Asian markets held their ground in the wake of the missile test. Japan’s 225-issue Nikkei rose 0.5%. Mainland China’s CSI 300 Index advanced 0.2%. Hong Kong’s Hang Seng Index also traded in positive territory.
The Japanese yen, a highly liquid global reserve currency, rose immediately after news of Pyongyang’s missile test. But the gains didn’t last very long. In fact, it took about three minutes for the yen to lose two-thirds of its gain. At time time of writing, the yen has moved into negative territory against its U.S. counterpart.
Japan’s currency is often seen as a gauge of global financial stress. Investors exchange other currencies for yen when they feel geopolitical unrest will impact the financial markets. Calm appear to have prevailed Friday morning.
Cryptocurrency Outlook Remains Negative
The global cryptocurrency market has shed billions this week as China expanded its assault on the asset class. Beijing has taken major steps toward closing its domestic bitcoin exchanges. Earlier this month, it announced a ban on initial coin offerings (ICOs), the breakthrough funding mechanism that has taken the world by storm.
The crash extended to all the major cryptocurrencies, including bitcoin and ethereum. The total market cap for the crypto asset class has plunged 35% over the past two weeks. As the following chart illustrates, the sky hasn’t stopped falling since Tuesday.
China’s position on cryptocurrency diverges sharply from that of neighboring Japan. The Japanese government has taken major steps toward recognizing bitcoin and regulating its use.
How have various asset classes performed during previous wars
North Korea, the dictator ruled nation has been threatening the US and its allies with a possible missile attack, which may also have a nuclear warhead on it. The experts are divided on the actual capability of North Korea to undertake the attacks, however, its leader, Kim Jong-un leaves no opportunity to provoke the US and its allies.
- Stocks perform better than average when the conflict starts
- Gold rallies before the start of the conflict
- Bonds have underperformed stocks during previous wars
- The US dollar has fallen on few occasions during a conflict
- The current war, if it starts, can severely impact electronic goods
- The US national debt is likely to balloon if US involves itself in South Korea’s reconstruction after the war ends
Though North Korea’s military prowess is nothing great to write home about, it can still cause extensive damage to millions of civilian lives and the economy of its neighbor South Korea, to some extent Japan and the US territory of Guam. However, in this article, we shall restrict ourselves to the impact of the war on various asset classes and the world economy. We shall use the historical evidence to arrive at our conclusion.
How does the US stock market perform during wars?
The US has fought several wars since 1960 as shown above. While a few ended quickly, others have been a long-drawn affair. Notwithstanding, Barron’s has outlined the effect of the following seven major hostilities on the Dow Jones Industrial Average since early 1980s.
|01||The US invasion of Grenada||1983|
|02||The US invasion of Panama||1989|
|03||The first Gulf War||1991|
|04||The US bombing of Kosovo||1999|
|05||The US War of Afghanistan||2001|
|06||The second Gulf War||2003|
|07||The US bombing of Libya||2011|
The markets hate uncertainty; a proof of this is the average 0.6% drop in the Dow a month prior to the start of the conflict.
However, once the conflict commenced, the Dow quickly turned direction, rising 4% in the first month. The rally did not stop there. Over the next three months, the Dow rose an average 6.7%, and the gains swelled to 7.2% after six months of the start of the conflict.
Therefore, if history repeats itself, a war between the US and North Korea – if it were to happen – will not start the next bear market.
How does gold perform during wars?
Gold is considered as a safe haven during times of uncertainty. Therefore, the yellow metal has rallied from about $1260/toz to about $1360/toz levels, as tensions escalated between North Korea and the US.
But, will gold continue its rally if the war starts?
Economists at Capital Economics have analyzed gold’s performance since 1985, during military conflicts, acts of terror and political tension.
They established that “over the past forty odd years, the price of gold has on average risen by 4.1% in the six months prior to a conflict turning into a full-blown war. However, it barely moved in the months following the event. This makes sense as gold thrives in periods of elevated uncertainty and the start of an armed conflict partly erases that.”
Performance of long-term bonds during wars
Though bonds are also considered as a safe haven investment, their performance has lagged their historical average during wars, according to a study by the CFA Institute. The possible reasons are an increase in inflation during war times and the second is the higher borrowing by the government to fund the war. Due to these two, bond prices fall. Therefore, selling out of stocks and buying bonds fearing a conflict might not prove to be a good strategy. The only aberration was during the gulf war when bonds beat stocks, albeit marginally.
How does the war affect the US dollar?
The evidence of the past three decades shows that the US dollar weakens during war, according to Kathy Lien, Managing Director of FX Strategy for BK Asset Management. The US dollar fell 5% when the Libyan war started and fell 9% during the first three months of the second gulf war. The dollar was weak even during the first gulf war.
However, this time, the situation is more complex and a lot of currency movements will depend on whether China actively involves itself in the war or remains neutral. The Australian dollar, the New Zealand dollar, and the Japanese Yen will see large moves if China supports North Korea directly during the war, else the movement in the currencies is likely to be comparatively subdued.
“As the tensions grow the dollar will suffer and the actual announcement of war could take USD/JPY to 105 but if it’s a swift victory the pair would also recover quickly,” said Kathy.
Though historical evidence gives us some idea about the possibilities, every new war is different because it involves different nations and affects different asset classes.
What sectors will be affected if a war with North Korea takes place?
North Korea, in itself, can’t impact commodity prices. However, it is surrounded by nations that are major consumers of commodities. China is one of the major consumers of commodities, however, it is unlikely that the war will impact China’s consumption materially.
South Korea is a major importer of coal and exporter of steel. Both these commodities will be majorly impacted because South Korea will be severely affected if a war breaks out. Similarly, liquified natural gas prices will be affected, as Japan is its largest importer in the world.
The seaborne trade will also be severely affected because China, South Korea, and Japan receive about one-third of the global seaborne crude supplies. Similarly, 84% of the world’s iron ore and 47% of the metallurgical coal reaches the shores of these three nations through the seaborne route.
The agricultural commodities will also be affected because China is a major importer of rice and soybeans while Japan is of corn.
Economic costs of the war
War has both a direct and an indirect impact on the economy. South Korea is a hub for manufacturing liquid crystal displays, semiconductors, and cars. A war will impact these activities, leading to a shortage across the globe. The alternative suppliers can’t bridge the gap in such a short span of time. Therefore, prices of various electronic products are likely to rise significantly, which will impact the developed economies, including the US.
“U.S. spending on electronic items, including smart phones, cameras, tablets and computers accounts for roughly 1 percent of the consumer price inflation basket. If a war in Korea caused prices of these items to double, it would add 1 percentage point to U.S. inflation,” a report by the research consultancy Capital Economics warned, reports CNBC.
If inflation rises sharply, the Central Banks will be forced to raise interest rates, jeopardizing the fledgling global economic recovery.
Additionally, if South Korea’s gross domestic product (GDP) falls by about 50% due to war, it will reduce the global GDP by 1 percentage point, according to the report.
Once the war ends, South Korea will need huge capital to rebuild its infrastructure. If the US involves itself and ends up spending the same amount as it did in Iraq and Afghanistan, then the federal debt will reach 105% of GDP, the economists at Capital Economics warned.
Though historical evidence suggests that the equity market returns are better than average during a war, the situation might be different this time because of the nations involved. Any jolt to the weak economic recovery across the globe will dent the confidence of the investors. Therefore, we don’t expect the stock markets to rise substantially during the war.
Gold’s performance is somewhat neutral and it can be used to protect the value of the portfolio. Therefore, selling some overvalued stocks and buying gold might be a good strategy if a war seems imminent.
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