Cumberland Advisors Market Commentary –  Defense Expenditures

Most Americans have never heard of the Stockholm International Peace Research Institute, www.sipri.org. A few minutes surfing their website might just inspire you to add it to your list of independent research sources.

Market Commentary - Cumberland Advisors - Defense Expenditures

You can check out the role of the military in Venezuela and how it is supporting Maduro as a result of the financial support the military has enjoyed. This mutually beneficial relationship helps to explain the difficulty of regime change in that country.

One can also check out many other informative research pieces.

Try the report “Trends in World Military Expenditure, 2018” (https://www.sipri.org/publications/2019/sipri-fact-sheets/trends-world-military-expenditure-2018). Take a look at Table 1 on page two for a summary of the 40 highest military expenditures, listed by country. The US tops the list. China is second. The economic data in this report helps to identify some macro themes. Worldwide military spending is estimated at about 2.1% of global output (GDP). America accounts for more than one-third of the world’s military expenditures. France spends more than Germany does. South Korea spends more than Brazil or Italy or Australia or Canada does. Macro data helps put things into perspective when that data is combined with geography.

One takeaway for us is critical.

We know the world is a dangerous place, and it seems that it is becoming more so. Traditional diplomacy seems to be failing. The latest North Korean missile firing is an example of this failure as Dictator Kim has demonstrated after two summits with President Trump. Let me be clear. Kim is a really bad guy. This next comment is about tactics and strategies and not in any way offered to protect or defend a strongman/dictator. Whether its Kim or Maduro or others, ruthless despotic dictators are the enemy, always and every time.

Note that a physical “walking out” of a meeting can occur only once in diplomacy and then the rules of engagement are forever changed. Ending a meeting without a joint statement used to be the way to message the world and the other side about discontent. No dictator/strongman leader can tolerate a direct insult since it raises risk to him from those at his home government who want to remove him or kill him. This is particularly so with dictators and strongmen who do not need to face elections.

So all the negotiations needed to deal with dictators and strongmen have now changed. The second summit with Kim was a victim of a real estate negotiating tactic. I’ve seen that tactic personally and used it on occasion. Negotiations can be tough and hard. So, you get up in the middle of a meeting to send a message that you are serious. You walk out. You also leave a channel open to resume if that is what you want to do. But in a business transaction, you do not have to proceed. That is why merger talks and transactional negotiations get broken off and then resumed.

In diplomacy, the reopening of a negotiation can happen but the methods used now have to be changed. The change occurs in the back channels and we do not see them in the public domain.

One side cannot take any risk or insult by the other side. Once you walk out the first time, you need to rewrite the rules. Unlike a real estate transaction, the “walking out” card can be played only one time. We shall see how the US deals with that principle in its global geopolitics. Negotiations between Trump and Xi are now subject to these new rules. The world’s two largest economies are also the world’s two largest military expenditures listed in the SIPRI report.

Meanwhile, the aggregate of military expenditures worldwide is heading higher and doing so from a record level.

We also know that the technology of war is intensifying at lightning speed. Check out: https://www.sipri.org/media/press-release/2019/emerging-technologies-pose-challenges-control-biological-weapons-new-sipri-report . Destructive capacity grows and is now expanded into the cyber realm. Here is another report to digest: https://www.sipri.org/research/armament-and-disarmament/emerging-military-and-security-technologies/cybersecurity . Nothing appears on the horizon to stem this accelerating trend.

At Cumberland, we continue to hold the defense sector ETF in our US ETF accounts. We rebalance it on weakness.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


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Geopolitical Risks in Emerging Market Equity ETFs

Last week included several dramatic examples of unexpected geopolitical developments in emerging markets: Two nuclear powers in South Asia, India, and Pakistan, clashed and appeared to be on the brink of full-scale war; and the US-North Korea summit in Hanoi ended badly, with Trump walking out.

Market Commentary - Cumberland Advisors - Geopolitical Risks in Emerging Market Equity ETFs

Also, unsettling markets were some negative signs about the state of US-China trade negotiations which, later in the week, were offset by some positive signs. With country-specific emerging-market equity ETFs, the risk of such geopolitical shocks is always present. It is interesting to look at how the respective national equity markets reacted to last week’s developments.

The India-Pakistan clash intensified last Tuesday, February 27, when Indian warplanes dropped bombs on a suspected terrorist camp inside Pakistan in response to a deadly terrorist attack on Indian soldiers earlier. Pakistan shot down at least one Indian plane and captured the pilot. Artillery barrages across the border followed, and thousands of troops converged. Pakistan Prime Minister Imran Khan then announced on Thursday that his country would release the captured Indian pilot, “In our desire of peace … and as a first step to open negotiations.” This move appeared to calm matters for the moment, but the situation remains tense. India’s stock market dropped sharply at first but later recovered as the situation eased. The iShares MSCI India ETF, INDA, finished the week up 0.4%. Clearly, should fighting resume, the market would tumble.

The long-standing India-Pakistan dispute over Kashmir is one of the most dangerous geopolitical risks. This clash is a reminder to investors that this risk should not be ignored. Indian stocks have been trending downward for fundamental economic reasons. Economic growth slowed to 6.6% in the fourth quarter of last year from 7% in the third quarter, which in turn was slower than the second quarter’s 8% growth rate. The ETF INDA is down 5% for the last twelve months ending March 1st and is down 2.3% year-to-date. Other emerging markets were also down last year. However, unlike Indian equities, most other emerging markets have rallied so far this year. The iShares MSCI Emerging Markets ETF, EEM, is up 8.8% year-to-date. Our International and Global ETF Portfolios are overweight in emerging markets, but we are not holding any India-specific positions.

The unpredictable North Korean regime and its nuclear capabilities constitute another dangerous geopolitical risk overhanging markets, particularly that of South Korea. The failure of the Hanoi summit appears to have resulted from inadequate preparations at a lower level and failure to recognize that the very complex and difficult issue of denuclearization could not be settled prematurely by a “deal” between two heads of state. There now is the risk that, following this humiliation for Kim, he will respond by moving to add to North Korea’s nuclear capabilities. Hopefully, seasoned diplomats on both sides will seek to restore the negotiations.

As was the case for India, South Korea’s stock market dropped in response to the bad news, with the iShares MSI South Korea Capped ETF, EWY, losing 2.2% over the week. But unlike the case for Indian stocks, the South Korean market has participated in the emerging-market rally so far this year. Despite last week’s losses, EWY is up 7.12% year-to-date as of March 1st. We are maintaining our South Korea positions in our International and Global Portfolios, while monitoring further developments closely.

The South Korean economy is strong, with close ties to the US economy. It is quite advanced and is considered by many to no longer be an emerging-market economy. The Korean equity market is large, accounting for 14% of the iShares MSCI Emerging Markets ETF, EEM, and is exceeded only by Hong Kong’s 23% share. China’s share in EEM is only 8%, but that does not yet include most of the Mainland China stocks. South Korea’s equity market is heavily weighted (40%) with technology stocks. Samsung Electronics alone accounts for 23% of the holdings. Long-term investors in South Korea’s equity market using EWY have done well: The annualized total return over the past 10 years is 12.37%.

Last week was also a volatile one for Chinese stocks, which lurched down and back up with each press comment and tweet hinting at the state of US-China trade talks or the severity of the moderation in the growth of China’s economy. In the end, the broad-based iShares MSCI China ETF, MCHI, was little changed for the week, with an increase of 0.5%.

There was a definite plus for Chinese stocks announced before the market opened on March 1st. The index publisher MSCI announced that it will quadruple the weight of Mainland China shares in its benchmarks. The benchmarks are the basis of many ETFs and funds. It is estimated that this quadrupling will lead to new passive inflows into Mainland China’s stock markets of some $US 80 billion. Chinese equities are also participating in the emerging-market recovery. MCHI is up over 16% year-to-date.

Investors who wish to limit exposure to the country-specific risks inherent in emerging-market stocks can invest in highly diversified ETFs that include stocks from a number of national markets. Two good examples are the ETFs EEM, mentioned above, and the Vanguard FTSE Emerging Markets Index Fund, VWO. Investors in individual-country ETFs need to monitor developments closely and seek to separate the noise in the daily news flow from developments that signal meaningful and lasting changes in the prospects for a market. Often events that capture the headlines for several days or more have little lasting market impact. At Cumberland Advisors we sort key signals from the noise by bringing together fundamental economic and financial analysis, technical market analysis, and geopolitical expertise.

William Witherell, Ph.D.
Chief Global Economist & Portfolio Manager
Email | Bio


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Sources: Financial Times, Wall Street Journal, CNBC.com, ETF.com


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Kim, Trump, Xi & Saving Children

We’ve collected a diverse set of quotes about Kim and Trump and Xi and the region as a whole. Of course, our vantage point for this assemblage is the United States, and our view is influenced by our financial, economic, and markets perspective.

Market Commentary - Cumberland Advisors - Kim, Trump, Xi & Saving Children

As we wrote in the four-part Thucydides series (see below), trade wars, shooting wars, and money wars are intertwined. That was so in the time of the Peloponnesian War and is just as true today.

Thucydides – series part 1: http://www.cumber.com/thucydides-part-1/.
Thucydides – series part 2: http://www.cumber.com/thucydides-part-2/.
Thucydides – series part 3: http://www.cumber.com/thucydides-part-3/.
Thucydides – series part 4: http://www.cumber.com/thucydides-part-4/

Here’s Adam Johnson in a recent Sunday morning Bullseye Brief:

“Fact is, tariffs of $50B on Chinese imports amount to one quarter of a percent of U.S. GDP. Additionally, they are dwarfed by $800B in stimulus from tax cuts, fiscal spending and offshore profit repatriation.” – Adam Johnson, June 17th  (https://bullseyebrief.com/current-issue/, subscription required)

How big is North Korea’s economy? Nobody knows for sure. Here is a June 10th Bloomberg story about estimates: https://www.bloomberg.com/graphics/2018-north-korea-economy-size/.

Steve Wasserman minces no words. This is why I asked for permission to quote the following summary. Thank you, Steve, for sharing this with our readers.

“Trump pulled off a truly history-changing summit, and of course the press are attacking without knowing what is really going on. Schumer claims Trump gave all, and got zero. How stupid. They claim having the two flags next to each other is ‘disgraceful.’ What would they do, have no N Korea flag. They say granting Kim a meeting is a win for Kim and a loser for Trump, and horrible to meet with such a terrible tyrant. Recall Roosevelt sitting with Stalin, Kerry with the Iranians. If you never meet with the really bad mass murderers, you never get anything done solving the really big issues, and you end up in a war. Hard to reach agreement if you do not talk to the other guy and only Kim and Trump can make decisions, so they had to meet. We do not know what Trump said to him. Maybe he said work with me or die, or words to that effect. We may never really know. Trump is used to talking to terrible people just like himself and the Mafia from his days as a NY real estate developer. He considers it normal to be lied to, mislead, and threatened. He was an expert at it. So when he said he prepared all his life that is what he was referring to, his NY real estate experience. We do not know, nor does the press, or the Dems, what Pompeo has been working on, nor what stage the agreements are at. Pompeo has had two teams, plus more back home, working around the clock on the details. They are not sitting around drinking tea. The Dems, the press, and conventional diplomats and academics just do not want to believe Trump really did this. Of course we need to see what happens. Of course we do not trust Kim. So he said no war games for now. No big deal. These are held in the spring. Lots of time to see if Kim sticks to the deal, and easily back on if not. War games are very helpful, but the rigorous training continues as before, so no real loss to our defense posture in Korea for now. He suspended, did not cancel. He gave a maybe, which is all. They met for five hours with Pompeo, Kelly and Bolton in the meetings, so they must have talked about a lot more than what is in that public statement. We need to see where this all goes from here, but for now there is maybe a real chance for a huge change in the prospects for peace in the region, and entire changes in how the US shapes history.”

I’m not sanguine about China’s intentions. In fact, I believe China has the US at a disadvantage that is not adequately appreciated. Xi doesn’t have midterm elections; he is president for life, and he has eliminated opposition. Xi has been quoted in the Western press as being opposed to lifetime rule; he has achieved just that through his internally controlled political system. As Richard Koo of the Nomura Research Institute notes, China is not only “trying to occupy the South China Sea, but it has eliminated term limits of the presidency, imprisoned human rights lawyers, restricted the freedom of the press, and is trying to place private companies under Communist Party control.”

Meanwhile, China’s military is conducting exercises: “A division of the People’s Liberation Army Air Force (PLAAF) recently organized multiple bombers, such as the H-6K, to conduct takeoff and landing training on islands and reefs in the South China Sea in order to improve our ability to reach all territory, conduct strikes at any time and strike in all directions.” Source: NightWatch, May 20th.

China did not mention which location was used. Open-source news agencies reported it was Woody Island in the Paracels. For the location of Woody Island, see this map: http://www.southchinasea.org/files/2013/03/Sovereignty-claims_in_the_south_china_sea-US-DoD-2012.png. Note that there are now three China-built runways on the island that can accommodate fighter aircraft.

The North Korea–China nexus is not well examined, in our view. It needs lots of ventilation and transparency. That’s hard to achieve when we are dealing with regimes like China and North Korea that stifle disclosure  and with regimes that continuously attack the free press (Trump’s war with “mainstream media”). In the US the division in the press is debilitating. Outlets like Bloomberg or Reuters or USA Today try to be even-handed and to practice responsible journalism. Opinions are clearly labelled as such. The range of others and their consistent biases are visible when you watch or read them side by side with the balanced ones. We frequently observe coverage of an issue both on CNN and on Fox in order to see how each of them handles it. We often compare the same reported story to the FT or WSJ or NYT versions. Internet-based sources are even more diverse and are dangerous to believe without independent verification. When it comes to the “fourth estate,” the demands on analysts are at an all-time high.

Let’s go back to China, North Korea, Trump, and US policy.

Singapore’s Straits Times reported that Kim had three planes at his disposal for the Singapore summit. Two were Boeing 747s handled by China Air, and the third was a North Korean IL-62. On his return to Pyongyang, only one of the Boeing planes flew to North Korea. The other returned to Beijing. NightWatch is one of the few sources to have followed this closely.

“It is almost inconceivable that [the Chinese Boeing 747] would have failed to carry a North Korean senior diplomat to back brief the Chinese leadership. Chinese Foreign Ministry daily press sessions implied the China was deeply involved in helping prepare Kim Jong Un for the summit.” (Straits Times)

Another important item that was not widely reported was a loan that China made to North Korea during the run-up to the Singapore summit. We have seen only one credible source (a private service) that describes it as “massive,” indicating that the loan was extended between the Communist Party of China and the Workers’ Party of North Korea. By using this technique, China can circumvent its governmental pledge to adhere to the UN-imposed sanctions.

There is also some reported restoration of the flow of goods and economic transactions between China and North Korea. China is calling that a private sector item so that it doesn’t run afoul of the UN sanctions. One reliable source indicated that the final terms of the massive loan would be implemented after the Singapore meeting. The implication is that China has a low profile but a lot of influence over the outcome of the Trump-Kim initiative.

Before we leave this region, we must comment on Japan. It is deeply involved in multi-dimensional ways in current East Asia geopolitics. For an excellent primer on Japan’s position and the political forces at work in Japan, see www.japan-insider.com. Jeff Usher’s paper entitled “Defending Japan,” dated May 13th, is a must for any serious student of the region and for any investor in the region. (What I like about Jeff is how he transfers his geopolitical analysis into actionable specific market recommendations.) In his paper Jeff includes the map of the Japanese air bases. It is important to look at this geography since Japan and the US have a multi-decade defense arrangement that allows the US to have an “unsinkable aircraft carrier” in the Pacific Ocean. With China’s expanding construction of military bases on islands and reefs, that equation is changing. Jeff notes the photo history (satellite)  of the Chinese build-out of the Fiery Cross Reef. Sources include Japan’s Ministry of Defense. See: https://www.google.com/search?q=fiery+cross+reef+before+and+after .

So where does this commentary end up? Nowhere. There is no end in view, in our opinion.

When it comes to the outlook for American politics, I have to agree with Steve Wasserman’s succinct summary:

“Trump, Pelosi, Schumer just add to the turmoil with their outlandish and stupid comments and tweets. Where is Ronald Reagan when we really need him? I fear we are in for several more years of Washington turmoil and ugly partisan battles. Nobody looks good in all this.”

When it comes to markets and interest rates and the economic outlook, the North Korea threat is now temporarily muted. But only temporarily, and only muted. We must consider that to be a success. The lack of a shooting war is in itself a success. And success must always be viewed as temporary. That is what vigilance and preparedness is really about.

The China trade war and the Trump-Xi tests of relative leadership, skill, and substance remain ahead. As we view this unfolding drama through the lenses of antiquity, today it is hard to know how to apply the metaphor of the past. We wonder if the US is Athens or Sparta; the same question is true for China.

We remain with some cash reserve. We worry about central banks’ decisions and behaviors, including our Fed’s. We worry about inflation or low-flation or no-flation, depending on how you measure it. And we worry about the US labor force and its demographic and income distributional characteristics. And lastly, we worry about our nation’s great legacy of enhancing our strength by accepting immigrants, a policy that has helped us for two centuries and is now threatened by the politics mentioned above and those internally, which I personally find abhorrent.

Now to a personal appeal to readers who may want to contact their Member of the House of Representatives.

Please note that presidents Obama and Bush had in common their personal and political intolerance for seeing a child yanked away from a mother who is seeking asylum from her home country where rape and murder are prevalent. The United States has always operated on the basic principle that our nation welcomes those who seek asylum from persecution. Whenever we have temporarily lost sight of that principle, we have paid dearly for the error.

And now, when the officer yanking the child away from its parents is wearing an American uniform, following a policy dictated by our president, Donald Trump, it makes for a very sad day in America. Such a policy is abhorrent and abusive. Shame on Donald J. Trump for every weeping child’s trauma, every parent’s despair and fear. And shame on some Senators, including McConnell and Schumer, and on Members of the House, including Ryan and Pelosi, our elected women and men, who cannot find a middle ground to solve this legislative issue.

There is an attempt to bridge the divide, and there are a number of House members from both sides of the aisle who tried to force a discharge petition and get this debate to the floor of the House. I personally applaud that effort and support them. I know one of them, Representative Carlos Curbelo, a Republican from Florida, who is putting his convictions and honor ahead of his political party. His family ancestors were persecuted by Fidel Castro, and he personally knows the value of asylum from a regime that tortures people and ignores any human rights. He has many colleagues, both Democrats and Republicans. They need to be praised.

By the way, I believe a bill passed by both Senate and House would be signed by President Trump. Democrats who do not want to give Trump a victory are just as responsible for the child being yanked away from the mother as are the Republicans who are tying up the bill because of other elements on their personal political agendas.

President Donald Trump will attend a House Republican conference meeting Tuesday night at 5:30 p.m. to talk immigration. (https://www.politico.com/story/2018/06/16/trump-capitol-immigration-talks-gop-650387) Readers have 48 hours to call a Republican congressional office and let the Member know they want this issue of immigrant children raised in the meeting.

David R. Kotok
Chairman & Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Kim, Trump, Thucydides

Trump’s cancellation of the Kim summit meeting clearly draws lines in the sand. Trump’s position cannot now be reversed for a longer period of time than was contemplated just hours ago. We now have an unpredictable escalation path.

Kim’s behavior in destroying tunnels, underground mountain rail lines, and other parts of his nuclear test site implies that he has lost the use of the facility. We do not know the casualties. The Kim family has practiced deceit for generations (three of them). US policy now realizes that hope is not a strategy.

Multidimensional issues abound: US–China, US–South Korea, other players in the region. What happens with Japan?

Bottom line is that the “peace breaks out” euphoria is now replaced with a more pragmatic set of facts. The Pentagon study on North Korea’s behavior only adds confirmation to the increasing risk assessment.

The implications for our dealings with Iran are a critical discussion item now. We must believe that Iran is watching the North Korean situation carefully. Remember that Iran is a customer of North Korean missile and other arms sales.

We have a cash reserve in our ETF accounts.

We are watching important lessons from ancient times playing out again. How much has humanity learned?

For Thucydides part 1, see: http://www.cumber.com/thucydides-part-1/

For Thucydides part 2, see: http://www.cumber.com/thucydides-part-2/

For Thucydides part 3, see: http://www.cumber.com/thucydides-part-3/




John McCain & Return of Prisoners

The morning email (today) from my friend Dennis Gartman really struck home with me. Dennis and I have a standing agreement to grant each other permission to quote each other. So here is what I read in Dennis’ morning missive:

170602-N-XK398-009 CAM RANH INTERNATIONAL PORT, Vietnam (Jun. 02, 2017) Senator John S. McCain III is piped aboard during a visit to the forward-deployed Arleigh Burke-class guided-missile destroyer USS John S. McCain (DDG 56). The U.S. Navy has patrolled the Indo-Asia-Pacific routinely for more than 70 years promoting regional peace and security. (U.S. Navy photo by Mass Communication Specialist 3rd Class Joshua Mortensen/Released)

“Senator John McCain has terminal brain cancer and shall soon pass from the scene. He was a hero in war; he was a hero in campaigns and he was a hero in taking the high road when then candidate Donald Trump said that he did not believe that Senator McCain was a hero or a winner because, in Trump’s very own terms, “Winners don’t get captured.” Mr. Trump was never in the position to be captured and tortured for several years as was young Lt. McCain at the time, for he avoided the draft and never served in Vietnam.

“Nonetheless, Mr. Trump referred to Senator McCain as a loser. It was at that point that we knew we were never going to be a Trump supporter, and although we voted for him we did so only because the other candidate was even more badly flawed.

“To fear the world we have organized and led for three quarters of a century, to abandon the ideals we have advanced around the globe, to refuse the obligations of international leadership for the sake of some half-baked, spurious nationalism cooked up by people who would rather find scapegoats than solve problems is unpatriotic.

“The Senator has asked that the President not attend his funeral, requesting that Vice President Pence attend in the President’s stead. We can fully understand. Were we Sen. McCain we’d not want someone who considers us to be a loser to be there supposedly to honor us in death.

“Sen. McCain was and is a great man, a great patriot and a great Senator. When he’s gone he will be sorely… very sorely… missed.”

Let me add some personal notes.

It is hard for anyone who has served in the armed forces in any branch not have the utmost respect and admiration for John McCain. I’ve had this discussion with many friends and have not found a single exception. While my military service in the Army came in the years 1966-69, my duty assignments did not include Vietnam. My personal visit to Vietnam came much later when I chaired a Global Interdependence Center Trip to Hanoi. During that trip some of us were able to break away from the meetings and visit the prison that held John McCain and see the cell he lived in. It was a moving experience.

We are now witnessing the return of three prisoners from North Korea. And no reasonable person would dispute that the release of these prisoners is a positive step. But their circumstances of imprisonment were different from John McCain’s. They weren’t shot down during a war. That said, we welcome their release as we would that of anyone held anywhere against their will and for doing nothing wrong.

History will note that the release of these prisoners from North Korea occurred on the watch of President Trump. And it has. But in our view, the reason why North Korea agreed to the release is secondary to the release itself.

These things happen when there is a détente. And right now there is an evolving détente underway between North and South Korea and directly involving the United States, China, and Japan. Reasonable people wish for that détente to succeed. Reasonable people want the risk profile of war lowered in the Asian region.

With regard to Senator McCain, Mr. Trump has a chance to demonstrate something that seems very difficult for him to do: He could apologize. He could show a side of his personality that might surprise some of his harshest critics. He could do it in the spirit of celebrating the prisoner release.

Wouldn’t it be nice of Mr. Trump to clear the air and offer an apology to John McCain while the Senator is still alive?

David R Kotok
Chairman & Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Coping with Geopolitical Risk: The Case of South Korea

Tensions have reemerged and reached a new peak on the Korean peninsula, following the sinking of a South Korean warship with the loss of 46 sailors, after it was struck by a North Korean torpedo.  South Korea moved to cut trade with the North by 50%, denied North Korean ships the use of its sea lanes, and designated the North as its “principal enemy,” a term that has not been used during the past six years of detente.  South Korea is calling upon the UN to censure North Korea. The US and South Korea have announced major combined naval exercises. Finally, in what can only be considered a symbolic move, the South has resumed broadcasting propaganda songs across the border.

North Korea Flag and Assembly

In response, the North banned South Korean ships and planes from using its airspace and sea lanes, said it was cutting all ties with the South, and will expel all South Korean officials from a joint industrial park in the North.  Ominously, there are reports that the North Korean leader, Kim Jong-il has ordered the North Korean military to be ready for war.  In the most recent escalation of tensions, North Korea threatened to scrap all “military assurance agreements” with South Korea. These agreements are safeguards against accidental armed clashes. They also protect the safety of South Korean workers in that industrial enclave in the North. U.S. and South Korean forces have elevated their five-step alert level by one step to the second highest level.

The implications of these geopolitical developments are quite different from those in Thailand. If this dispute remains a shouting match, with saber rattling, posturing, and the exchange of commercial and political sanctions, the effects on the Korean economy and its equity market, while negative, would likely remain modest. However, should armed conflict erupt, the effects would disastrous for both the North and South and would be heavy also for China, Japan, and the South’s main ally, the United States. It would seem that everyone should want to avoid that outcome.  China, which has the most leverage over the North, certainly wants to avoid the massive influx of refugees that would develop. The South, backed by the US, would eventually “win” but at a terrible cost, particularly to its main population center, Seoul, which is located within range of the massed artillery just across the border. And one must not forget that North Korea may well be able to deliver nuclear or biological weapons. No rational government would go down this path. “Dear Leader” Kim, however, is not known for rational thinking, and the uncertainties surrounding his eventual succession contribute to the dangerous situation.

Before these developments, the South Korean economy was on route to a healthy recovery. GDP growth looked to be on track for almost 6% for the current year.  South Korea has been benefiting from the strong growth in the region, particularly in China, the largest export destination for Korea. Exports account for half of South Korea’s GDP. The MSCI Index for the Korean equity market advanced by 4.03% on a total-return basis in the first quarter, which was better than the 2.45% advance in the MSCI Emerging Markets benchmark.

As of May 27 th however, the MSCI Korea index was down 16.57% from the end of April, a rough period for most emerging markets, with the MSCI Emerging Market Index losing -10.97 %. The KOSPI index actually rose 1% on the 28 th.  Apparently, while international investors have scaled down their Korean exposures, domestic investors have shrugged off the heightened tensions and gone bargain hunting.

At Cumberland our Korean positions in our international and global portfolios were already underweight compared to the heavy weight of Korea in the MSCI Emerging Markets benchmark, about 13%. We have preferred a more diversified exposure to the economic recovery in Asia.  While we think the most likely outcome of the current confrontation between North and South Korea will be that war will be avoided and economic recovery in the South will continue, the situation on the peninsula together with the current “risk-off” sentiment in global markets is likely to lead risk-averse global investors to refrain from adding to their exposure to the South Korean equity market.  We have further reduced our positions in the Korean ETF, EWY, preferring other Asian equity market ETFs for the time being, as indicated in our Commentary on Thailand.