Tensions between the US and North Korea have risen to an unprecedented level this week, prompting some commentators to suggest that nuclear war could well be on the cards. Experienced investors have also voiced such fears to AsianInvestor, although the markets’ reaction has been fairly muted so far. But concerns are undoubtedly growing amid the rapid escalation in rhetoric.

On Saturday the United Nations Security Council – with China's backing – imposed strict new sanctions on North Korea, which reacted furiously.

Then US president Donald Trump on Tuesday threatened North Korea with “fire and fury like the world has never seen” if it were to attack the US. North Korea responded by saying it was “carefully examining” the possibility of a strike on Guam, an American territory.

Trump yesterday further ramped up the rhetoric with more tweets touting US military might.

Political motivation?

So is the American president, having failed to push through various parts of his reform agenda, looking to regain political capital with his bellicose stance?

Han Tongli, founder and chief investment officer of Hong Kong-based DeepBlue Global Investment, thinks so. He went so far as to say he wouldn’t be shocked if Trump were to start a war with North Korea.

Many of the president’s reform proposals have not been approved, so a war may help boost his political power, Han told AsianInvestor, noting: “In the US, president has the right to start a war without getting voting approvals.”

Karine Hirn, Hong Kong-based partner at emerging-markets fund house East Capital, made a similar point. Trump has not been able to achieve various domestic goals, she said; but he does not have the same constraints – at least not domestically – when it comes to the American military.

Tit-for-tat

What’s more, saving face is very important in Asian culture, noted Hirn. With his aggressive stance, Trump is leaving Kim Jong-Un very little room for manoeuvre in this respect, she said. The more fierce the rhetoric on both sides, the more likely it is that the North Korean leader feels he would be losing face if he were to back down.

“Tension between the US and North Korea is not new,” Hirn pointed out. “What is new here – and what makes it scarier – is that we get to experience it in real time by following the tweets of President Trump. We didn’t have this amount of information before.”

As the Economist Intelligence Unit put it in a note yesterday: “The danger in the US’s strategy of matching North Korea’s shrill rhetoric is that the escalating threats lead each to assume that the other is moving closer to an attack, until such a confrontation becomes inevitable.”

DeepBlue’s Han certainly thinks it makes sense for markets to adopt a risk-off stance. The value of save-haven assets such as gold, US Treasuries and Japanese yen, is set to rise, he said. “In addition, stock markets around the globe have been rallying this year and need a correction.”

As a result, Han said he had taken very low risk in his portfolio since June, by keeping about half of his fund in cash.

“Bluster and posturing”

Others, however, are dismissing the Kim-Trump stand-off as bluster; a movie that has been seen before.

“Markets (even South Korea) have tended to react less and less to this posturing,” wrote Nicholas Melhuish, global head of equities at Amundi, in an email to AsianInvestor. The Kospi benchmark stock index fell just 1% yesterday.

The current market moves are likely to be driven by short-term traders rather than long-only investors, he said. “I would imagine that there will be some shifting of allocations if the rhetoric looks like it might lead to something."

Indeed, East Capital’s Hirn said that as a long-only investor her firm would not be doing much in reaction to the latest developments. She is more focused on the potential benefits for emerging markets, and especially Asia, if China were to succeed in defusing tensions.

The broad expectation seems to be that Beijing will prevent the situation from escalating; it already intervened yesterday to appeal for calm. 

If the situation does not worsen, the China-US relationship will be strengthened, noted Hirn, reducing the chance of a trade war between the two. “This would be positive for emerging-market sentiment and particularly for Asia.”

Many will be hoping Beijing plays its part.