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Geopolitical Tension: What Investors Should Know

The stock market was briefly rattled in early August, when President Donald Trump promised to unleash “fire and fury” on North Korea—whose leader, Kim Jong Un, later issued a direct threat against the U.S. territory of Guam.

Although Kim appeared to back off that threat in subsequent days, the situation may remain in the headlines, particularly while the United States and South Korea conduct scheduled military exercises in August. Should investors be worried about ongoing geopolitical tension?

“The best-case scenario is that the situation remains a battle of wills and rhetoric between the two leaders, without significant military action,” says Liz Ann Sonders, chief investment strategist at Charles Schwab. “The worst-case scenario is significant military escalation leading to all-out war. We—collectively, the Schwab Center for Financial Research and Schwab’s experts in Washington, D.C.—view that probability as presently low.”

Reversal(s) of fortune

The initial effect of the battle of wills between Trump and Kim was a swift reversal in U.S. stocks, with the S&P 500® Index dropping nearly 1.5% on the day the tension and threats initially erupted, then recovering quickly.

The dip occurred in the midst of a long-running, low-volatility rally: This was only the fifth time so far in 2017 that the market was down more than 1%, and it marked a reversal from what had been all-time highs. All in all, market strength has been remarkable: According to Bespoke Investment Group, since 1928 there have only been eight other years when there were fewer than ten 1% moves at this point in the year, and only three years when there were fewer than five. In all eight years, the market had positive returns during the remainder of the year, with an average gain of more than 8%.

While it’s possible events in North Korea could still create significant market shock; over the past few decades similar events generally have not had a long-lasting impact on stocks, Liz Ann says. For instance, The Wall Street Journal recently analyzed 80 international incidents involving North Korea and its nuclear program since 1993 and found little connection between tensions on the Korean Peninsula and financial markets.¹ The 36 North Korean nuclear or missile tests detailed by the Arms Control Association were followed on average by a decline of 0.4% for the S&P 500 in the subsequent trading session, with a rally thereafter in the majority of instances.²

In sum

The stock market continues to receive support from strong U.S. corporate earnings and revenue growth, as well as deregulation efforts in Washington, D.C.; a “Goldilocks” not-too-hot, not-too-cold global economic/inflation environment; and still-ample global liquidity.

“Ultimately, those are the primary drivers of where stocks are in their cycle,” Liz Ann says. “Yes, this bull market will end eventually; but it’s unlikely that tensions between North Korea and the United States will be the catalyst for that, barring an escalation into a war.”

What investors can do now

In general, the Schwab Center for Financial Research says the best way to prepare for potentially volatile markets is to take the long view and make sure you have a diversified portfolio based on your risk tolerance and investing timeline. Various asset classes—stocks, bonds, cash investments and other vehicles—tend to perform differently in any given market environment. Holding an appropriate mix of investments can help smooth the effect of volatility on your portfolio and help keep you on track toward meeting your investment goals.

It's also important to rebalance your portfolio as necessary. Market changes can skew your asset allocation over time, as investments that gain in value will become a larger part of your portfolio while declining investments will shrink relative to the rest of your holdings. Periodic rebalancing can help ensure that your portfolio still reflects your target allocation.

¹“Trump’s Fury Over North Korea Means Little for Stocks,” The Wall Street Journal, August 11, 2017.

²Ibid.

What You Can Do Next

  • Market volatility is unnerving, but it’s a normal—and normally short-lived—part of investing. If you’ve built a solid financial plan and a well-diversified portfolio, it’s best to ignore the noise and focus on your long-term goals. Want to talk about your portfolio? Call our investment professionals at 800-355-2162.
  • Watch Schwab experts discuss other market and economic topics in the Schwab Market Snapshot.
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Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Investing involves risk including loss of principal.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower rated securities are subject to greater credit risk, default risk and liquidity risk.

Diversification and rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.

Past performance is no guarantee of future results.

Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.

The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.

The S&P 500 Index is a market-capitalization-weighted index that includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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