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Will North Korea's Nuclear Test Cause U.S. Markets to Slide?

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On Sunday, North Korea raised global geopolitical tensions after it claimed it had conducted a sixth and substantially more powerful nuclear test. This announcement also significantly increased pressure on the Trump administration, representing the most serious foreign affairs crisis in years.

Much of this depends on how the United States ultimately responds to this latest provocation from North Korea. However, initial reactions suggest that policymakers are still weighing their options and are likely to issue a studied and measured response.

This is why the impact of this event on the U.S. bourses will largely be limited to the short term. At the same time, a flight toward safe haven assets and another surge in popularity of defense stocks is likely as developments surrounding North Korea continue to unfold.

Mattis Issues Stern Warning

On Sep 3, North Korea claimed that it successfully tested a hydrogen bomb capable of being fitted onto an intercontinental ballistic missile (ICBM). In a televised statement, the country claimed that the test was a “perfect success” and guaranteed that North Korea now possessed a credible nuclear warhead.

Reacting to the test, U.S. Defense Secretary James Mattis issued a stern warning to North Korea. Mattis said the errant country would have to face a tremendous military response if it indulged in an act of aggression against the United States or its allies.

Over the last few weeks, the Trump administration has hinted that it will explore further steps to isolate North Korea’s economy following its recent actions, especially with regard to testing of missiles and nuclear weapons. Future attempts to curb the country economically could include increasing pressure on China to stop its oil imports to North Korea, a move which could cripple the country in several ways.

Defense Stocks to Gain

Apart from economic sanctions, the prospects of U.S. military action against North Korea have also increased following Mattis’ strong response to the nuclear test. Given such a backdrop, U.S. defense stocks are likely to mop up considerable gains in the days ahead. Reports from South Korea hinting at further missile tests by its Northern neighbor, including an ICBM launch, are likely to provide further impetus to this sector.

This in keeping with gains enjoyed by defense stocks in the aftermath of last week’s missile launch over Japan. On Aug 29, North Korea fired a ballistic missile which flew over Japan's Hokkaido island before crashing into the sea. Following this event, stocks such as Raytheon (RTN - Free Report) General Dynamics (GD - Free Report) , Lockheed Martin (LMT - Free Report) and Northrop Grumman (NOC - Free Report) moved north. Each of these stocks have a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Popularity of Safe Haven Assets to Rise

Meanwhile, South Korea carried out live-fire drills, intended to exhibit the country’s military strength, as a response to the nuclear test. Additionally, it is speeding up the deployment of the U.S. manufactured THAAD missile defense system. It comes as no surprise, therefore, that the popularity of safe haven assets is on the rise.

Since Sunday’s test, treasuries, gold, the yen and the Swiss franc have all found favor with investors. But such a state of affairs is unlikely to last beyond a point. In the past, investors have participated in a short term selloff and rushed toward safe haven assets in the aftermath of such an event. Subsequently, they have bought the dip soon after receiving indications that tensions have eased or are unlikely to escalate further.

In Conclusion

North Korea’s latest nuclear test is likely to add to U.S. investors’ woes in the week ahead. But this set to be a short term phenomenon, given that U.S. military action in the region still seems unlikely. Given such prospects, markets are likely to focus on strong economic fundamentals and bullish earnings performance of stocks. This means that a major stock slide, even in the midterm, seems unlikely. Stocks are likely to return to their winning ways once tensions begin to recede.

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