ECB looms larger than North Korea over European stocks

North Korea’s latest nuclear provocation is a serious distraction for European stock markets, with the emphasis on ‘distraction’

North Korea’s latest nuclear provocation is a serious distraction for European stock markets, with the emphasis on the word ‘distraction’.

Even as signs mount that the so-called ‘hermit nation’ is preparing an imminent missile launch—its 15th this year—after detonating its most powerful nuclear device on Sunday, we expect economic and political conundrums to keep exerting more of an influence on Western markets as we wrap up the third quarter and head into the last.

Asia Pacific markets bore the brunt of risk-averse selling on Monday, but by the time Europe’s most active centres opened, negative sentiment was similar to that of many other recent down days. Neither the FTSE the DAX nor the STOXX benchmark traded more than 0.5% lower on the day. This year’s dearth of U.S. stock market volatility doesn’t show much sign of evaporating either. The VIX Volatility index, like cash equities, was closed for a U.S. public holiday but VIX futures ticked 5% higher. That would equate to a lift of the underlying index to well below this year’s meagre highs. Key U.S. stock index futures also looked barely perturbed, trading down about 0.2%-0.3% a piece.

A key takeaway from Monday’s stock market reaction then is that whilst North Korea has apparently decided to ratchet inter- and intra-regional tensions higher this year, other factors are likely to continue exerting a stronger influence. There have been 14 N. Korean missile test days in 2017 compared to just 5 in 2016, and 3 of the country’s six known nuclear weapons tests since 2006 occurred in 2016/17. Regardless of its specific strategic aims, North Korea is projecting increasing determination to be regarded as a nuclear power. There’s no downplaying that the republic’s move into a more active phase of symbolic aggression is another geopolitical unknown for investors to keep tabs on. But unless the frequency of missile and nuclear tests increases exponentially, we expect U.S. investors to remain more concerned about the ability of their administration to come good on tax cut pledges.

North Korea is clearly not the chief ‘threat’ to European stock markets either. Investors are much more concerned about the euro. In Europe, particularly this week, investors will be more concerned about whether the ECB judges the risk to Europe’s corporate earnings rebound from the euro’s rise as severe enough to lengthen its timetable for the removal of unconventional policy.  The short answer seems to be ‘no’. The ECB has mediated concern over the part played by its communications in the euro’s 8% rise this year. That suggests it will avoid triggering further melt-ups where possible, but postponement of a likely announcement about tapering from this year to next is not feasible whilst Eurozone growth and business sentiment continue to match and often beat expectations.

Anxieties around the single currency began to clip the wings of Europe’s STOXX benchmark index in the spring and it has underperformed the S&P 500 since then. However, it is also worth noting that easing investor interest in the region is partly a function of demand for emerging market equities, and that relative to U.S. stocks, demand for European equities is firmer. The Eurozone recently saw its first equity fund net outflow in seven weeks compared to the U.S., which is on its worst run of outflows since 2004. U.S. cash-focused funds saw their largest monthly inflow since 2012 in August, according to Lipper data released last Friday. Emerging market equities continue to show the best cross-asset performance, returning some 27% year-to-date in dollar terms.

Investor anxieties about North Korea remain proportionate.

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