There is a trade lurking behind many of the day’s headlines. Sometimes, the trade will be rather simple to identify. At other times, finding the trade may require a little more research. That is the case with today’s trade idea. We will explain the thought process as an example of how the news can lead to a trade.
Among the week’s biggest stories has been North Korea’s launch of a true intercontinental ballistic missile (ICBM). On Monday, North Korea tested an ICBM for the first time.
Some experts said such a missile could reach Alaska or go even further toward the US mainland. But there was widespread skepticism of the North’s claim of the missile being able to “strike any place in the world.”
US Military officials said the missile flew for 37 minutes before splashing down in the Sea of Japan. Moscow’s defense ministry called it medium-range. But Japanese defense officials estimated the maximum altitude to have “greatly exceeded” 2,500 kilometers.
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A n independent analysis by the Union of Concerned Scientists concluded the missile had “a maximum range of roughly 6,700 km on a standard trajectory. That range would not be enough to reach the lower 48 states or the large islands of Hawaii, but would allow it to reach all of Alaska.”
Rhetoric ramped up quickly. North Korea’s possession of a working ICBM is something that President Donald Trump had vowed “won’t happen.”
North Korean leader Kim Jong-Un called the missile “a gift” to “American’s” on the US Independence Day holiday, the Korean Central News Agency reported. North Korea’s official news agency quoted Kim, who personally oversaw the test, as having inspected the missile and “expressed satisfaction, saying it looked as handsome as a good-looking boy and was well made.”
But, experts questioned what could be done. Sanctions have failed to stop North Korea’s progress in the past.
What’s Next for Investors?
Defense officials and diplomats around the world are struggling to address this problem. An attack on North Korea is risky because North Korea has positioned as many as 8,000 artillery cannons and rocket launchers on its side of the Demilitarized Zone, analysts say, an arsenal capable of raining up to 300,000 rounds on the South in the first hour of a counterattack. Diplomacy is also risky but may be the least objectionable solution.
The challenge for investors is to understand what is likely to happen in global stock markets. There is no stock market in North Korea so that leaves three markets to consider – the United States, Japan, and South Korea.
While North Korea might be able to attack the United States, that appears to be an irrational act. Kim Jong-Un doubtlessly understands that would result in a large counterattack that would threaten the survival of North Korea. This indicates US markets are unlikely to see significant impacts unless a full scale war develops.
Japan is within range of North Korea’s missiles. But, an attack on Japan would also lead to a counterattack that threatens the regime. More likely is an accident. North Korea has experienced numerous failures in its missile tests.
Failures are a part of any program like this. They are inevitable as engineers push the limits of their knowledge. This means an error could cause a missile to land in Japan, or even South Korea. If it was an error, Japan is unlikely to respond with force. But, South Korea could be drawn into conflict.
That makes the South Korean market the most likely for a reaction to this news.
A Look At Stocks In South Korea
Fundamentals point to South Korea as a strong buy. iShares MSCI South Korea Capped ETF (NYSE: EWY) provides US investors with access to the market. The fundamentals for the holdings of this ETF are shown below.
Similar values for the US market are significantly higher. The P/E ratio of the holdings of SPDR S&P 500 ETF (NYSE: SPY) is 19.87. The P/B ratio for SPY is 2.79. The P/S ratio is 2.09 and the P/CF ratio is 11.46. With vales that are about half of the US ratios, and even lower in some cases, the South Korean market is fundamentally undervalued.
Investors should also look at technical analysis for a picture of a stock market. Here, the picture is less clear. EWY is a long standing resistance level on the monthly chart which is shown below.
The weekly chart shows that prices have fallen back below that resistance line. This chart also includes MACD, a momentum indicator at the bottom of the chart.
Momentum broke to new highs as prices rallied in the first six months of the year. But, MACD has declined sharply while prices have only sold off a small amount. Technical analysts believe that momentum leads price. In this chart, MACD is warning of a price decline.
A sell off after breaking above resistance is not unusual. Long term investors may not pay close attention to the market action and they learn about the new high at different times. They respond by selling, perhaps because they finally broke even. But, this process can be slow.