Forget North Korea – Something even more sinister is lurking in the shadows

north_korea_-_Google_SearchBy David Nelson, CFA

The usual suspects’ valuation and politics both played a role in last week’s market decline. However, it’s safe to say rumors of another nuclear test on the Korean peninsula forced traders to the exit as the S&P 500 (SPY) closed at the lows of the day, week and month heading into the Easter Break.

At least as of this writing, the nuclear test never materialized but we did get another missile launch after a Saturday parade of North Korean military hardware, including what many believe may have been an ICBM. While the launch was a failure, tensions are high and National Security Advisor Lt. Gen. H.R. McMaster said; “all of our options are on the table…”

Markets in the short run hate uncertainty and there’s nothing more uncertain than a seemingly unstable young dictator screaming for attention by threatening a nuclear response. North Korea reaching nuclear launch capability is about as serious as it gets. But for investors it’s hard to deny that something even more sinister may be lurking in the shadows.


The R Word

My usual bullish spirt was dented last week watching ten year yields break key support levels at 2.3% putting in question the reflation trade. The breakout I expected at 2.6% hasn’t materialized so any additional hikes by the Fed this year would help flatten the yield curve. This in turn could send economists back to the bunkers lowering forecasts even forcing some to use the R word (RECESSION).


Unless inflation picks up steam the Fed will be forced to delay or at least reduce the number of hikes this year and will soon be reflected in the dot plots we’ve become addicted to. (A flat yield curve often happens in front of a recession)

The rush into Treasuries (TLT) and the mother of all safe haven trades Gold (GLD) is to be expected during times of geo-political tension. However, again it is likely not the only issues weighing on investors.

The failure of the GOP Healthcare plan puts in question other parts of the administration’s agenda including market friendly policy like tax reform, repatriation and de-regulation. These have real economic outcomes and if they don’t come to pass the earnings bump many were counting on will at best be delayed. In other words, perception meets reality.

Selling into good news usually speaks to underlying issues the market hasn’t come to grips with. While Wells Fargo’s (WFC) earnings left much to be desired, JP Morgan’s (JPM) numbers showed strength across the board. Strong investment and commercial banking helped drive returns and net interest margins increased 11 basis points to 2.33%.

Never the less both along with the entire sector were for sale. Possibly a lot of late money that has come into financials looking to cut losses helped accelerate the decline. In addition, concerns have been mounting regarding loan growth and net interest margin gains may stall if the Fed starts to get cold feet regarding rate hikes.


After two weeks of declines investors are nervous and with another heavy week of earnings ahead they’ll be searching for answers and guidance from management. Yes, we’re only marginally off the all-time highs with strong support just below the 100 day moving average. At best it’s going to take weeks to repair the technical damage.

The market will have another chance to redeem itself this week as a large number of companies report earnings across nearly every sector of the economy. As analysts we’ll delve deep into the numbers but in the end the price action that follows we’ll be the real report card.

*At the time of this article some funds managed by David Nelson were long SPY, JPM, TLT, GLD & WFC