North and South Korea are inching closer to peace — and it could have as big an impact on markets as the fall of the Berlin Wall

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KCNA/Reuters

  • North and South Korea are about to embark on a series of talks aimed to de-escalate the tensions between the two nations.
  • Such a de-escalation could have a major impact on markets, with Morgan Stanley seeing a jump of almost 15% in local stocks if peace is achieved.
  • Even if tensions are pacified somewhat, Korea’s benchmark KOSPI could rise as much as 8%.

With North Korea and South Korea making tentative steps towards a de-escalation of the decades long conflict between the two nations, some analysts have started to think about what a more liberal, open North Korea without nuclear weapons might mean for the world.

Writing this week, a team from Morgan Stanley’s South Korean operation analysed the situation in the two nations ahead of upcoming talks, and argued that any continued de-escalation of tensions could end up being a major economic and market boon for Asia, and possibly the rest of the world.

Morgan Stanley lays out possible scenarios that could materialise in the aftermath of the upcoming talks, which it calls:

  • “Breaking the ice” -Relations between the two nations improve and some economic ties are re-established.
  • “Becoming more engaged” – In this scenario, relations don’t improve by a huge amount, but North Korea liberalises trade and the movement of people.
  • “Full Union” – Seemingly the least likely scenario right now, this would see North and South Korea unify on economy and policy.
  • “Uneasy equilibrium remains” – Highly possible, this scenario would see talks making little or no progress.

Under the first scenario, Morgan Stanley’s team argues, the KOSPI – South Korea’s stock exchange, and home to major brands like Samsung, Hyundai and LG – could see an upside of as much as 8%, largely because improved relations would make a conflict between the two, possibly involving Western intervention, far less likely.

“We would expect a partial allaying of the geopolitical discount, but sentiment would unlikely to reach a state of exuberance,” the team of analysts wrote.

If talks end even better, and the Koreas end up in either of the “Becoming more engaged” or “Full Union” scenarios, the upside to the KOSPI could be as high as 15%, the report argues.

Here’s what the authors say (emphasis ours):

“In a scenario where the market believes the Becoming More Engaged or Full Union scenarios look likely to come to fruition in a relatively short period of time, which would entail definitive and genuine progress in the same direction by the key stakeholders, we believe the market could strongly re-rate and possibly overshoot our expectations. We assume 10-15% upside to KOSPI in this scenario.”

For a historical precedent, Morgan Stanley looks to the experience of the market after the fall of the Berlin Wall and the reunification of German in the early 1990s.

“When the Berlin Wall fell on November 9, 1989, it triggered significant excitement about the outlook for the economy on the back of potential reunification. The equity market rallied for around two months, with the DAX index climbing 28%,” Morgan Stanley noted.

However, that jump ended up being a huge overreaction, with stocks falling sharply soon afterwards. It is possible a similar pattern could emerge in Korea, the team say.

“One of conventional behaviors observed from equity markets is that they have a tendency to exhibit sharp rallies on major catalysts without properly incorporating the risks and impediments into the measurement,” they wrote.

“An event like the resolution of geopolitical risk related to North Korea could be such a catalyst, in our view.”

Here’s Morgan Stanley’s chart, showing the initial jump in German stocks after the Berlin Wall fell, followed by their sharp drop soon after:

Screen Shot 2018 04 26 at 13.44.09

source
Morgan Stanley