Date: August 11, 2017

North Korea was the Excuse

While North Korea is now front and center in the mainstream news as well as the financial news and the financial markets are now fixated on North Korea, the stock market was already positioned to retreat for the past few weeks. It was just looking for a catalyst. I started writing about the likelihood of a pullback beginning in late July as you can read, HERE, HERE, HERE and HERE. As you know, I have been resoundingly bullish all year and targeted Dow 23,000 by Q4 which I pushed back to Q1 2018. This is not the case of a bear who has been wrong just getting louder. It’s the most negative I have been all year although as you will read, I am still not calling for anything dramatic on the downside.

Historically, I have pretty much dismissed saber rattling as a one or two day market event where the markets quickly resume their prior trends. That’s been especially true of North Korea as it seemed like they just wanted world attention. The exception was Iraq in 2003 as it became clear it was only a matter of time before the bombs started flying.

Having been in the business for 29 years this month, I have learned enough to fill an entire Encyclopedia Brittanica series. In the late 1990s, I learned a valuable lesson about using 4 very dirty little words. “This time is different.” It rarely is. Regardless of the technology or societal advances, human behavior just doesn’t change. Markets oscillate between fear and greed. Regarding North Korea, I do not have the same feeling as I have had in the past. I know. I know. Feel is not real.

Russia and China both voted with the U.S. and the rest of the UN’s security council on the sanctions. That may not seem important, but remember, Russia occupied North Korea after the war and China was an ally during the war. Until the Soviet Union fell, Russia was North Korea’s protective big brother. In recent times, China has been North Korea’s quiet trading partner. Having both of them vote against North Korea, this is a huge sea change.

Additionally, I have heard through my channels that both Russia and China have amassed and continue to build through troop strength along their borders with North Korea. This is not normal activity and leads me to believe that Russia and China no longer think that Kim is just playing childish games. The two countries are preparing for something militarily. Whether that’s defensive or offensive remains to be seen. I do think that any unprovoked military action by Kim will be responded to very harshly by the U.S., Russia and China. If I lived in South Korea, I would be very worried right now.

I also think that whatever is going to happen with this current incident, it’s happening right now, meaning we are in it already. It could end this weekend with some kind of back door deal or it could escalate over the coming days and weeks. It will be interesting to see how President Trump handles all this. Is he combating a bully by pushing back or is he serious about action? Bluffing? Looking to make a deal? I have always thought of Trump as someone who beat his chest to scare and intimidate, but back down when push came to shove. We will see…

Back to the markets, before North Korea was on the markets’ radar screen, I discussed a number of short-term concerns. Before I get into them, my intermediate and long-term views remain absolutely the same. The bull market is alive and reasonably healthy for being 8+ years old. My next upside target is 23,000 by Q1 2018.

With that out of the way, my short-term worries lead to me conclude that a normal 3-5% pullback is underway. Of course, stocks could overshoot a few more percent, but I do not believe the stock market is in the early stages or approaching a 10%+ correction. The downside risk looks to be over the next month or so.

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Paul Schatz, President, Heritage Capital