The odds of a North Korea war and how that will impact the U.S. stock market

Events in the U.S. and around the world are changing so fast right now that we need to update our market outlook very often.
The risk of a U.S. – North Korea war is increasingly likely. It may happen in the next 2 months. The S&P 500 will most likely make a big correction (fall 12%, 13%, 14%, or 15%+). Historically, the S&P ALWAYS made a big correction when the U.S. was on the verge of going to war. However, the S&P will not enter into a bear market. This is still a bull market.

Why the U.S. increasingly has no choice but to go to war.

We typically ignore all news from North Korea. The Kim family has threatened to “bomb” the U.S. for decades, so it’s like the “boy who cried wolf”. However, this time might be different. The wolf is coming.
The North Korea nuclear program has developed to the point where they can build a nuclear bomb every 5-6 weeks now. However, North Korea needs to develop ICBM technology that can go far enough to hit America with those nuclear weapons. North Korea’s current technology is not capable of doing this. But at North Korea’s rapid rate of technology development, North Korean nukes will be able to hit western United States cities like Seattle by 2020.
Emboldened by technological success, North Korea’s Kim is making serious threats against the U.S. North Korea is even threatening to bomb long time ally China, which shares a long northern border with North Korea.
Trump and China are working together on this. North Korea basically blackmailing the outside world: give us money and supplies or we’ll nuke you. China and the U.S. have 2 choices:

  1. Pay North Korea an obscene amount of money right now. North Korea will merely use these resources to secretly develop its nuclear program even more rapidly. In a few years, North Korea will ask for even more money via more dangerous threats and more ICBM nukes.
  2. Attack North Korea now, annihilate all of North Korea’s nuclear facilities and depose Kim Jong Un.  Stop this problem right now. Since China doesn’t want to be surrounded on all sides by U.S. allies, China will likely install a subservient puppet regime that ends North Korea’s nuclear program.

Ultimately, these 2 scenarios lead to the same result. Put yourself in the shoes of a politician like Trump or China’s president.

Would you rather attack North Korea in the future when they’re more dangerous, or make a pre-emptive strike right now when the situation is containable?

That is why China and the U.S. are making preparations for war. Why pay North Korea now and go to war in 4 years when you can fight a much easier war now? And Trump has no choice but to deal with this. By the time North Korean nukes can hit Seattle in 2020, Trump will still be president. He will have to deal with this problem during his presidency anyways. He cannot leave this problem to the next President like Obama did. So he might as well deal with it now instead of in 3 years. And a war will only boost Trump’s approval ratings.
Right now Trump is calling China and Japan every week. Japan – America’s lapdog – is mobilizing its military as well. Perhaps they are coordinating an attack?
Here are the signs of an impending war.
China has moved 150,000 troops to the Yalu river (border of North Korea and China). It is also amassing weaponry along the border.
It is increasingly likely that Trump will go to war too.

  1. Yesterday Trump briefed all 100 Senators at the White House. This is extremely unprecedented, and usually occurs when the President needs Congressional approval for acts of war.
  2. Meanwhile, the U.S. has sent multiple aircraft carrier task groups and submarines to the Korean Peninsula. In addition, America has set up the THAAD anti-missile defense systems in South Korea. The U.S. has sent Navy Seal Team 6 to train with South Korean special ops.

The most likely outcome for this war and the U.S. stock market.

History shows us how wars typically play out. A prime example is the 2003 Iraq war.

  1. There are rumors that the U.S. might go to war in the weeks/months preceding the actual war. During this time, the president makes sure that Congress will go along with the war.
  2. Then the President justifies a pre-emptive strike on “national security” grounds. “The rogue nation has weapons of mass destruction”.
  3. Then things start to escalate quickly. The U.S. gives the rogue nation (i.e. North Korea) an ultimatum. Stop nuclear development and allow our inspectors in. Or else war.
  4. The rogue nation ignores this final warning, thinking “the U.S. won’t actually fight us. And if they do, we can win!” (It’s shocking how much confidence dictators have in themselves. Saddam Hussein in 2003 actually believed that Iraq could withstand a U.S. attack. That is the nature of dictators. They have so much confidence in themselves that they are blind to obvious facts.)
  5. The U.S. immediately starts to bomb the rogue nation, and a war ensues.
  6. A quick victory.

How the U.S. – North Korean will play out this time.

There isn’t strong support for a war with U.S. boots on the ground. So here’s what will likely happen.

  1. South Korean and Chinese troops make a 2 pronged attack against North Korea.
  2. U.S. provides firepower, air support, etc. Perhaps a few of the American troops stationed in South Korea will aid in the attack, but the U.S. will avoid sending a lot of men in. Body bags don’t make for great PR.
  3. Kim will be deposed and China will install a puppet regime that doesn’t threaten the world like the Kim’s have.
  4. The crisis ends quickly. China and the U.S. quietly negotiate how to carve up North Korea.

How the U.S. stock market will react

Historically, the buildup to every U.S.-involved war has caused the S&P 500 to fall at least 10%! WWII, 1950 Korean War, Vietnam War, Operation Desert Storm, Operation Iraqi Freedom, etc.
At first when the media starts to talk about a U.S. war, the S&P doesn’t really react. But once it becomes increasingly certain that the U.S. will go to war, the S&P starts to fall. Sometimes the S&P bottoms when the fighting starts, and sometimes the S&P bottoms after the fighting starts. Then the S&P rallies vigorously because it’s still a bull market.
So here’s what we’re going to do.

  1. We will not sell stocks right now. Perhaps a deal will be struck and there will be no war. Like the “boy who cried wolf”, you have no idea when the U.S. will announce a war. In addition, the U.S. stock market has a bullish bias right now because the U.S. economy and corporate earnings are growing nicely.
  2. But if a war does begin, remember that the S&P always lags world events. The S&P will only fall AFTER it becomes very clear that a war will happen.
  3. We will sell stocks and shift part of our portfolio into cash AFTER it becomes clear that a war will begin. How will we know when to sell? Perhaps we’ll sell when Trump gives North Korea an ultimatum.
  4. Right now we are 100% long UPRO, the 3x ETF or the S&P 500. This means that our portfolio magnifies all of the S&P’s gains/losses by 3x.
  5. Perhaps this will be the first time in history in which the S&P does not go down during a U.S. war. But we’d rather not take our chances and be highly leveraged like we are right now.
  6. We’ll sell 2/3 of our UPRO, leaving us with 2/3 cash and 1/3 long UPRO. This means that if the S&P 500 goes up, we will participate in the stock market’s gains. But if the S&P goes down, we will buy stocks at a much cheaper price when this big correction bottoms.
  7. Our model will tell us when to buy and shift to 100% long UPRO again. Perhaps the “buy” signal will come out when the S&P falls 12%, 13%, 14%, or 15%.

When Trump gives North Korea an ultimatum, Kim will reject it instantly. A similar thing happened in 2003. President Bush gave Saddam Hussein an ultimatum on March 17. Hussein rejected that ultimatum on March 18, and the U.S. started to bomb Iraq on March 19. All in a span of 3 days.

What the doomsayers got wrong

  1. This will be a short and swift victory. U.S. + China vs North Korea = game over. Let’s not kid ourselves. Perhaps this will only take 1 week.
  2. This war will have ZERO impact on the global economy and corporate earnings. That is why the U.S. stock market is still in a bull market. Fears of collateral damage are pointless. Yes, perhaps a few cities in South Korea and China will be bombed, but that is irrelevant. In the grand scheme of things this is a drop in the bucket.
  3. I don’t want to argue whether war is good or bad for the U.S. economy. That is irrelevant. But history shows us that U.S. wars always push the S&P down first and then up.

Side effects

The U.S. dollar will go up and U.S. treasury yields will go down because investors look for a “safety haven”. Perhaps gold will go up or down. Who knows. Gold doesn’t always play a safety haven. For example, gold spiked in 2003 on war news but quickly started to fall.
Trump’s approval ratings will go up like Bush’s did in 2003. This war is the one thing that both Democrats and Republicans can support.

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