Geopolitical Risk Update: Korea & Brazil

Conclusion: Geopolitical tensions continue to heighten in Korea and violence continues to flare up in Brazil.

 

On a sleepy Friday that equates to a half-day for many U.S. market practitioners, it’s important to remember the old adage, “markets wait for no one”. While it may be en vogue to chat about “Black Friday” and how many handbags Coach is going to sell this year, the fact of the matter is that there’s a great deal of geopolitical risk globally that you should keep on your radar screen as you head into the weekend.

 

First, an update on the situation brewing on the Korean peninsula:

 

North Korea’s state news agency KCNA warned that any “escalated confrontation” will lead to war and that the government is “greatly enraged at the provocation” from South Korea. Further, it strongly reiterated that any further encroachment of its sovereign territories will lead to retaliation. This marks the fourth time this week Kim Jong Il’s regime threatened further strikes against its Southern neighbor. In a show of bravado following the aggressive rhetoric, the North fired a few explosives on Yeonpyeong as part of its regular artillery drills from 12:00-3:00pm local time.

 

In the latest move to counter mounting political pressure for a stronger response, South Korean President Lee Myung Bak appointed former Joint Chiefs of Staff Chairman Kim Kwan Jin to defense minister. Jin, 61, replaces Kim Tae Young, who quit amid criticism that the response to Tuesday’s attack was inadequate. Young originally offered his resignation back in May, two months after the S. Korean warship Cheonan was sunk by the North and South Korea failed to respond in kind.

 

This latest appointment may potentially be a step in the more aggressive direction, which, on the margin, increases the probability of a full-out military conflict in the region.

 

From a quantitative perspective, South Korea’s KOSPI index remains bearish from an immediate-term TRADE perspective and ever-so-slightly bullish from an intermediate-term TREND perspective:

 

Geopolitical Risk Update: Korea & Brazil - 1

 

We remain bearish on Korean equities for two main reasons: 1) growth looks to slow sequentially for the next 2-3 quarters; and 2) inflation will continue to be a headwind and will require more aggressive tightening of monetary policy.

 

Moving over to Brazil, we see the death toll from the violence in Rio has increased to over 30 from as few as 13 on Wednesday. In response, President Lula has dispatched 800 army troops into the region to join forces with the 17,000-plus police that are swarming the city’s streets. Newspapers from Germany to Spain to Australia (i.e. nearly everywhere, but the U.S.) are calling the move both “unprecedented” and “desperate” and are also calling into question Brazil’s ability to guarantee security for visitors of the upcoming World Cup.

 

Other reports cited in the Brazilian press point to the estimated tens of millions of reais of lost revenue in Rio’s businesses.  The umbrella organization representing the trade, retail and tourism industries said one day’s closure of the major outlets in the areas of Rio affected by the violence represents R$ 39 million in lost revenue. The violence is having a broad effect as other companies not in the affected areas let workers return home early to avoid the evening hours when the streets are more dangerous.  This includes such major enterprises as Petrobras.  Companies are reporting worker absences of up to 30% and schools and universities have cancelled classes as terrorized residents remain indoors to avoid the danger of traveling across Rio.

 

Brazilian intelligence sources report Rio’s two major criminal gangs are planning a “mega-action” for tomorrow.  Presumably the military was called up in anticipation.  This could be incredibly ugly, as Rio’s heavily-armed police are reputed to have zero regard for human life once they enter the favela neighborhoods.

 

From a quantitative perspective, Brazil's Bovespa is bearish from an immediate-term TRADE perspective and bullish from an intermediate –term TREND perspective, though it is trading below its TREND line of support of 68,826 intraday. A close below that line is an explicitly bearish quantitative signal – particularly if it is confirmed by further weakness:

 

Geopolitical Risk Update: Korea & Brazil - 2

 

We remain cautious on Brazilian equities for the intermediate-term TREND. While we stand behind the robustness of Brazil’s bullish consumer story, we are cognizant of the intermediate-term inflation risks and the potential for further tightening of monetary policy in 1H11.

 

Darius Dale

Analyst

 

Moshe Silver

Managing Director / Chief Compliance Officer


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