Three Scenarios for Trump-Kim Talks:
Good, So-So, and Horrible

Art by Vinnie Neuberg

Talk about big stakes. The outcome of talks between President Donald Trump and North Korean leader Kim Jong-Un will impact trade with China, South Korea’s economy, and the world’s capital markets.

There are three likely scenarios on how the Trump-Kim summit will fare, with results ranging from good to so-so to horrible, according to investment strategists and economists. Asset managers and investors need to pay attention, because the aftermath of the parley could have repercussions far beyond the Pacific Rim.

Right now, with both sides maneuvering over the talks (where and when to hold them are the leading issues), little market reaction has shown up in the West. Despite Kim’s claims that his missiles can reach the US mainland, few Americans are worried about them at present. As developments unfolded in early March about the prospects of a summit, the Standard & Poor’s 500 barely budged.

Not so in South Korea, which is sitting next door to the North’s weapons, its capital of Seoul a mere 40 miles from the border. The Kospi Composite jumped 4.5% in the week in early March when North Korea proposed and the US accepted holding talks. That marked the South Korean index’s largest increase this year. In Japan, also within easy range of Kim’s arsenal, the Topix index enjoyed a small but significant bump during the same period.

Of course, looming in the background like a specter from the Cold War is the threat of an armed conflict that could involve nukes, which would be catastrophic for all of humanity. Trump wants North Korea to shed its nuclear weapons, and Kim seeks assurance that his nation – and his regime in Pyongyang – are safe from the US military.

The delicate problem for the president is that China, which is North Korean’s chief ally and trade partner, will be a factor in the Trump-Kim negotiations. “The US will need China’s cooperation,” wrote David Woo, a Bank of America Merrill Lynch analyst.

Trouble is, a wicked trade dispute is brewing between Washington and Beijing. Trump has slapped China with billions in tariffs, retaliating for its intellectual property theft and unfair trade practices, and the Chinese have responded with their own levies. “Overlay the current trade war with China, North Korea’s grand protectorate,” said Dave Haviland, managing partner at Beaumont Capital Management, “and we have a nasty-tasting soup.”

The trio of scenarios stemming from the Trump-Kim confab, assuming it happens, are:

Success: A grand bargain is struck with the North giving up or freezing its nukes and opening themselves to outside development, in return for a peace treaty with the US.  From the American and South Korean perspective, the ideal next phase would be an influx of investment into North Korea, which would benefit the South’s huge construction companies. “It is literally an untapped market ripe for modernization,” Beaumont’s Haviland said.

While spending to re-build the North might drain the Seoul government’s coffers, reminiscent of the reunification of hardscrabble East Germany with prosperous West Germany in the early 1990s, the removal of war risk could attract more foreign capital to the peninsula.

The downside would be that export-dependent South Korea would see its currency, the won, appreciate – and “a strong won is not necessarily a favorable macro development” for the South’s overseas trading, said Simona Mocuta, senior economist at State Street Global Advisors.

How stock and bond markets would react to an agreement is more difficult to gauge. It’s not as if the world were sitting on the brink of extinction, as was the case during the 1962 Cuban missile crisis. Thus don’t expect a spasm of relief in the US, with mass jubilation in New York’s Times Square and a huge surge in the S&P 500.

Absent any hope of greater integration between the two Koreas, but with an end to war worries, then “the markets will rally for a day or two, if that, and there will be no meaningful economic consequences,” said economist David Levy, chairman of the Jerome Levy Forecasting Center. “Maybe a little more tourism and investment for South Korea.”

Just the same, a lot of skepticism abounds, given the intransigence of the various players in this game, that a grand bargain can be struck. “We might as well expect money to fall from the heavens and all the national leaders joining together to sing kumbaya, because it’s not happening,” Levy said.

Muddle: Nothing is agreed on, and diplomat-level negotiations start that wind on and go nowhere. This is the likely outcome, in the view of economist Gary Shilling, who heads a consultancy carrying his name. Trump will be asking too much of Kim, he believes, such as rigorous inspections. So “in the final analysis, nothing really happens,” he said.

Such a blah upshot won’t make the markets very happy, contended economist Hugh Johnson, head of his own eponymous consulting firm. While the various parties will congratulate themselves, “investors with higher expectations or hopes will see through this,” he said, leading to “a downward reaction in most global markets.”

Nevertheless, the mere existence of negotiations “would be a positive, considering the current state of affairs,” State Street’s Mocuta said. Markets eventually could hearten, she maintained, if the Korea talks produced the side benefit of defusing the US-China trade clash because the world saw its two largest powers cooperating.  

Failure: The session ends in acrimony. We’re back to where we were with threats and the possibility of war. Trump said last week that he would abandon the talks if they’re “not fruitful.” Suspicions are rife in both camps because a previous deal, almost a quarter-century ago, broke down.

Under the 1994 Agreed Framework, the Clinton administration got North Korea to OK shutting its plutonium reactor, which could be used to make bomb-grade material, in exchange for fuel oil to make up the loss of the plant’s electrical generation. But when the Bush administration took over, it accused Pyonyang of cheating by enriching uranium elsewhere to build bombs.

Should the Trump-Kim talks collapse, “the financial markets are likely to decline sharply,” economist Johnson said, with stocks in the Far East the worst off. If Kim’s government threatened to launch a rocket delivering a 40 kiloton warhead anywhere in the US – that’s twice the size of the payload of the 1945 Nagasaki bomb – the New York Stock Exchange would not take the warning in stride.

How China chooses to play its hand is key. Sure, Beijing would prefer neighboring North Korea to denuclearize, noted Stefan Selig, a former undersecretary of commerce for international trade. Holding the Chinese back, however, is “the chance that at some point the peninsula gets reunified and falls into the US orbit, and China has a staunch American ally on their border,” added Selig, now managing partner at BridgePark Advisors.

To be sure, impoverished North Korea, further hobbled by international trade embargos, has an incentive to strike a deal. “They cannot afford to come away from these negotiations without something that gives their country some relief,” economist Johnson said.

 Amidst all the questions about how this situation will play out and what its economic implications are is one stark reality. As State Street’s Mocuta pointed out: “It is essentially impossible to price nuclear war.”