‘Robot Monster’: Pricing In ‘Physical Annihilation’

Listen, you’ve probably read all kinds of commentary about how there’s no way to hedge against a nuclear war. Commentary which suggests that because it’s effectively impossible to hedge for the apocalypse (unless you count hoarding bullets, kerosene, and Chef Boyardee), you might as well buy yourself some South Korean stocks. Because after all, earnings are growing and valuations are (extremely) attractive.

Kospi

That point of view is consistent with the avalanche of inflows into South Korean assets in H1 and also with the Kospi’s great year.

But that’s an example of investors’ inherent propensity to whistle past the proverbial graveyard. And indeed, it’s an intellectually dishonest way to “explain” an obviously absurd investment thesis. Let’s face it, North Korea could nuke Seoul tomorrow and the world would not immediately end. There would still be some trading to do. Only not in South Korean assets, because they would no longer exist. So, I wish people would stop framing this in terms of: “well, you should buy the Kospi because if our worst fears are realized on the Korean peninsula, nothing will matter anyway.” That’s disingenuous.

And indeed, there are signs that some folks are getting nervous. “Much has been made of the insouciance of markets as the leaders of the first nuclear-armed nation and perhaps the latest trade insults,” Bloomberg’s Garfield Reynolds wrote overnight, before noting that “some cracks are appearing to signal that the tremors caused by geopolitics are having an impact.”

For instance, Reynolds notes “the sudden 3 trillion won bond selloff last week as some foreigners decided they weren’t willing to hold South Korean debt heading into a six-trading day break.” Here’s Goldman with the breakdown:

Foreign outflows from bonds were much larger (than stocks). Weekly net investment in bonds reached -W3.1trn, the largest negative number since Oct 2016. Compared with end-Aug, foreign investors’ bond holdings fell by W6.0trn (largest change since Dec 2010), with outflows largest in 3-5yr maturities (W3.7trn) and 10-15yr maturities (3.6trn).

But more poignantly, have a look at this chart:

CDS

South Korea is now being treated by the market as more risky than Thailand.

As Reynolds concludes:

The difficulties of trying to trade assets in a nation that offers great rewards, but stands almost alone in also carrying the risk of physical annihilation somehow remind me of the catch line from 1953’s “Robot Monster,” a classic, truly awful cult sci-fi film: “I cannot — yet I must. How do you calculate that? At what point on the graph do ‘must’ and ‘cannot’ meet?”

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