The growing tensions between North Korea and the US are not likely to turn into war, even though the current outlook does provide worrying room for miscalculations. Actions such as flying strategic bombers near North Korea are not the kind of thing to reassure investors.
We have been here before with North Korea though: it is important to remember that the two halves of Korea never actually made peace. The armistice of 1953 was simply a ceasefire and a state of war still technically exists. There have been previous moments of crisis, most recently in 2010, when the North sank the South's corvette. But with the North now possessing an enhanced nuclear capability, the possibility of terrible destruction in South Korea, Japan and perhaps even the US West Coast has increased dramatically. And, of course, we now have a US president whose reactions are far harder to predict. With Donald Trump threatening North Korea with terrible destruction, it is easy to see why the situation is worrying investors.
However, assuming that war is not the end result, we should be looking at the kind of sectors that may well see investor inflows. The most obvious is, of course, the defence sector. President Trump has previously indicated that he wished to boost defence spending, and the standoff with Pyongyang will give him a further reason to act on this. The sector includes such names as Boeing, Lockheed Martin and Raytheon, but the iShares US Aerospace and Defense ETF would provide a means of getting exposure to a broad number of stocks, rather than simply concentrating on a few.
Since mid-2012, the exchange-traded fund (ETF) has gained almost 160% versus a more modest 70% for the S&P 500. Clearly, defence stocks do well, even without the threat of armed conflict hanging over the Korean peninsula. Earnings growth in 2016 was 5.2%, while this is expected to keep rising in coming years. A new $700 billion defence bill from the US Senate will provide further business, including 94 F-35 jets, made by Lockheed Martin. This number is greater than that asked for by the White House, and more than that agreed by the House of Representatives.
Away from defence, it makes sense to think about utilities. This ‘defensive’ sector is noted for its higher yields and generally lower volatility. In times of stress, investors tend to shun high-growth stocks, like those found on the Nasdaq, for those with reliable, if unexciting, earning streams. A yield of almost 3% for the iShares US Utilities ETF, plus strong yields for UK stalwarts such as United Utilities and National Grid, will help to offset capital loss in times of risk aversion for stocks.
Overall, it still does not look as if we will see conflict in Korea. However, defence stocks will remain popular, and should see gains if further nuclear tests occur or if rhetoric between Trump and Kim Jong-Un is stepped up. This situation is unlikely to go away in the near future.