Geopolitical Risks Soar While Major Markets Seem Increasingly Complacent

The last few months have seen a growing number of tensions, with seemingly disconnected events causing little reaction in an equity market that seems very expensive to some veteran investors. In addition to the domestic issues that President Trump is navigating after the attack in North Carolina, the potential nuclear standoff with North Korea isn't going anywhere.

Equity markets don't seem to be responding to any great degree to these risks, and in fact, the S&P 500 is sitting within a single digit percentage of its all time closing high of 2,480.91. The VIX, which is a measure of implied volatility in the S&P 500, is still hovering around 14. This is hardly a sign of geopolitical risks being taken seriously, but over the last week some experienced market participants have sounded warnings that haven't been widely reported on.

Rothschild Isn't Adding Risk

Lord Jacob Rothschild, who is the Chairman of the Rothschild Investment Trust (RIT), issued a strongly worded note to investors in RIT recently. To quote Lord Rothschild:

“We do not believe this is an appropriate time to add to risk. Share prices have in many cases risen to unprecedented levels at a time when economic growth is by no means assured.” After commenting on the valuations in equity markets, he states that, “The period of monetary accommodation may well be coming to an end. Geopolitical problems remain widespread and are proving increasingly difficult to resolve.”

This is a serious statement from a man who has helped to achieve market outperformance over the last few decades on a scale that few can match. He is clearly talking about the rising tensions that exist in many areas of the world, and the sparse solutions for clearing them up.

North Korean Stalemate

President Trump isn't mincing words with North Korea, and according to a Chinese think-tank, the U.S. doesn't have the option to intervene on the Korean peninsula militarily. In a recent report they state that President Trump's position is designed to leverage China, and not much more. This looks to be a very curious assertion, and one that may not be accurate.

There is a long standing dedication in the United States to prevent a nuclear-capable North Korea, and with the latest generation of North Korean ICBM's that are potentially a risk to U.S. territories, the likelihood of a U.S. strike on North Korea is growing. Pyongyang has publicly threatened the island of Guam, which is host to vital U.S. military bases. It is unknown how credible these threats are, but if the Pentagon does take them seriously, a U.S. strike on North Korea would seem to be more a question of timing.

Chinese Algebra

It's no secret that Beijing wants more autonomy in Asia, and less U.S. power in what it sees as its backyard. The constant incursions by U.S. Navy vessels into the disputed waters of the South China Sea are evidence of Washington's attempts to exert authority in the region, and Beijing isn't happy about being put on the spot. North Korea is off limits for a first strike, according to a recent statement from China, so if the U.S. does decide to hit North Korea, they will be challenging China to a degree that may not be acceptable to Beijing.

The response from China to violent U.S. intervention on their borders is impossible to anticipate, but it is worth remembering that China has the largest air force on the planet, and some of the most advanced missiles that exist. They are especially adept at building land-based anti-ship missiles, and once the shooting starts, all bets are off.

It is unlikely events like this are currently reflected in the present valuation of the S&P 500, or the price of precious metals. It may be worth keeping an eye on how the North Korean situation develops, and unfortunately, it is one of many that may expose markets to unexpected volatility. This may be why an investor like Lord Rothschild isn't adding risk at the moment, and has yanked a significant amount of RIT assets from the U.S. markets over the last six months.