An improvement in relations between the US and North Korea is good news for investors, writes Ed Wiltshire.
4 minute read
At those moments in the past 18 months when President Donald Trump and North Korea’s Supreme Leader Kim Jong-Un engaged in a high-stakes game of chicken involving the threat of nuclear missiles, the idea of a summit meeting between these supposedly irrational and erratic leaders seemed a distant prospect.
The planned summit in the Lion City of Singapore on June 12 could yet be cancelled. But at the time of writing it still seems likely that Trump and Kim Jong-Un will come face to face. While a complete thawing of relations between the two countries may be a stretch, these unlikely dance partners should at least be able to manoeuvre their respective states back to a stable equilibrium.
Kim: from pariah to peacemaker
Having seen the fate of Saddam Hussein and Muammar Gaddafi, Kim Jong-un (and his father before him) could see the obvious dangers of being a dictator who did not enjoy the friendship of the US. North Korea’s desire to develop nuclear weapons was an entirely rational response to protect the current regime: the failure of successive US presidents to nip this ambition in the bud has meant that Donald Trump has been left holding the parcel now that the music has stopped.
With his nuclear programme near to completion and, more importantly, seen by the US to be so; Kim is in a strong bargaining position. The Winter Olympics in South Korea provided eye-catching window dressing to start his diplomatic overtures. Progress since then has been swift: Kim’s first trip to Beijing as Leader; the new US Secretary of State’s visit to Pyongyang; the gentle two-step of the Korean presidents over and over their controversial shared border; and the release of three US citizens detained by North Korea. Some 65 years after the Korean War stopped; there is even talk of a formal peace treaty.
Of course, much could yet go wrong with the Singapore summit. The possibility expectations have already run ahead of the challenging realities of the situation means setbacks and disappointments may be unavoidable. The path to any peaceful equilibrium may continue to prove hair-raising for viewers of the news and volatile for the equity markets.
However, all sides have a huge incentive for some kind of agreement to be reached. Trump wants to reassure his constituency, preferably before the midterm elections in November, that Kim is no threat to the mighty US. Kim wants an end to sanctions, supported as they are by the Chinese, so that he can attempt to rebuild the North Korean economy. China would like to see a troublesome neighbour brought to heel and no longer be an additional irritant in the already testy Sino-US relationship. Both South Korea and Japan would like to avoid the risk to their citizens of overflying test missiles.
Easing market jitters
So what is the prize for equity markets if a deal can be reached? While it may be some time before anyone rushes to snap up shares in North Korean telecoms company Koryolink or the Pyongyang Chewing Gum Factory, international investors should see some definite near-term benefits. First of all, a major geopolitical risk, one that could potentially have led to war, will have been taken off the table. It has certainly been the case that every test carried out by North Korea and every rhetorical response from Trump’s twitter account have caused global equity markets to flinch.
Unsurprisingly, this has been particularly evident in the oscillations of the South Korean KOSPI equity index. The liquidity of shares in household names such as Samsung, Hyundai and LG make it easy for jittery investors to flit in and out of this market. Geopolitical stability on the Korean peninsula could translate directly into lower volatility for the local equity market. Economic co-operation between North and South could be another huge prize, opening up a market desperate for infrastructure improvement to the construction and utilities companies of South Korea.
The biggest near-term prize could be the restoration of good relations between China and South Korea, which had soured due to developments in the North. In 2016, Seoul responded to Kim’s acceleration of his nuclear programme by agreeing to accept the US’s THAAD anti-missile system as a deterrent. Beijing objected to having such a sophisticated US-operated radar system so close to its own borders. Despite these objections, the first THAAD unit arrived in South Korea in mid-2017.
Beijing expressed its displeasure through a number of measures directed at businesses and exporters that included a ban on organized tourist trips to the country. Korean cosmetics enjoy a particular vogue in China, but they suffered a double whammy. Fewer Chinese tourists meant lower sales in duty free shops, while exports were impeded by specific bans. At one point, a leading Korean exporter was ordered to destroy 730kg of cosmetics by Chinese customs on the grounds they contained ‘hazardous substances’.
Patriotic ire was harnessed as part of an unofficial boycott of Korean goods. Though other factors were also at work, it was no coincidence Korean brands were the worst hit automobile sector in China in 2017 as deliveries were down 36 per cent on the previous year.
Korean conglomerate Lotte Group was even harder hit when one of its country clubs became the location of the first THAAD unit. The department store subsidiary Lotte Shopping had over one hundred stores in China. Most of these were forced to suspend operations after the Chinese authorities unexpectedly found they were violating fire safety regulations. Despite fixing the issues, fire authorities have not re-inspected the stores and they remain closed. Efforts to sell them have also stalled as buyers cannot be certain they will be allowed to reopen the stores.
Part of the club
There are signs that as the North Korean situation moves towards a peaceful resolution, relations between South Korea and China are moving back towards more fruitful co-operation. Given China is their largest trading partner; this is good news for South Korea. Meanwhile, the protectionist rhetoric of the Trump administration is only likely to drive them closer together. Indeed, this was the message that emerged from a recent trilateral summit in Tokyo between the Chinese premier, the Japanese prime minister and the South Korean president. Li Keqiang called for the three countries to strike their own trade agreement.
If Trump and Kim’s dream of a Nobel Peace Prize may seem a little over-optimistic at this point, it doesn’t seem too Panglossian to believe some sort of deal will be reached. Not full denuclearization perhaps, but something that reassures all interested parties – the US, China, South Korea, Japan – Kim’s toys will remain in their box and the expertise his regime has gained will not be sold on to the highest bidder. A reluctant acceptance then that North Korea is now a member of the nuclear club and willing to be a responsible one. In return, sanctions could be lifted and Kim would be free to engage in the world economy and, where possible, normalize his regime’s relationship with other countries. The hermit kingdom could finally come out of its shell.