On November 23, North Korea opened fire on the South Korean island of Yeonpyeong in a deadly three-hour skirmish that left buildings ablaze and residents fleeing for shelter. This was the "first land attack since the end of the Korean War in 1953."
In the world of fundamental analysis, this is what's known as the "Grand Poobah" of market-moving events. An act of "war" does to stock markets what a category five hurricane does to a coastal sea village: It sinks it. On this, the following news items from November 23 say plenty:
- "Stocks Rattled By Global Tensions" (Reuters)
- "Stocks To Face Selling On Korean Shelling" (Nikkei.com)
- "Korean Clash Sends Stocks Tumbling" (AP)
We at Elliott Wave International see this rationale as exactly backwards. While news can cause stock market volatility, it does not create broad trends. On the contrary, the most extreme news events often mark the markets' turning points. Socionomics (the new science of social forecasting based on the Wave Principle pioneered by EWI president Robert Prechter) explains that markets are the proxy for collective psychology (or social mood), which unfolds in Elliott wave patterns on price charts. A rising mood creates bull markets and (among many other social manifestations) a political climate of cooperation; a falling mood ushers in bear markets and political confrontations.
And, most importantly, contrary to the conventional understanding of news and events and their presumed effect on the financial markets, when fears are fully realized by the public, it usually signals a bear market bottom; when hopes are realized, a bull market peak is often close at hand.
To see how this socionomic model applies to the North-South Korean relationships, in the September 2009 issue of Elliott Wave International's monthly Asian-Pacific Financial Forecast, editor Mark Galasiewski presented this chart of how South Korea's KOSPI index has reflected the region's social mood fluctuations (Elliott wave labels not shown):
"We assume that the KOSPI also measures the mood in North Korea," wrote the September 2009 Asian-Pacific Financial Forecast, "because its leadership monitors the south closely. In the end, even estranged siblings always have an interest in each other."
You then glean the following insights from the corresponding analysis:
In early 1993, the KOSPI hit bottom after enduring a three-year long, 55% sell-off to multi-year lows. The bearish psychology was fully entrenched, and relations between the two Koreas were taut. The North kicked out inspectors from the International Atomic Energy Agency and was allegedly starting a nuclear weapons program. The South convinced the U.N. Security Council to invoke sanctions on the North -- which the latter denounced as an "act of war."
But as collective psychology lifted (as shown in the chart above by the rising KOSPI), discord turned to accord. In late 1994, North Korea and the U.S. signed a promise to abide by the nuclear nonproliferation treaty (NPT). The show-of-unity was the first of its kind in 40 years and a perfect correlate to a peak in social mood, as the KOSPI subsequently plunged 75% from 1994 to 1998.
Other notable socionomic milestones include:
- 2002-3 lows in KOSPI: A low in social mood produces deadly skirmishes between North and South Korea. The North announces its intention to withdraw from the NPT and effectively ends the Agreed Framework.
- October 2007 peak in KOSPI: A peak in social mood sees North and South Korea sign the "Peace Zone" -- a monumental promise to "not take a hostile stance toward each other and resolve issues of conflict through dialogue and negotiation." Shortly after, the KOSPI lunged head first into a 60%-plus decline.
The socionomic link continues to this day, as the current outbreak of hostilities coincides with the flagging performance of South Korea's financial markets: In September 2009, the KOSPI small cap and mid-cap markets peaked, while the larger KOSPI fell 12% and made no net progress for the next nine months.
Find out the next chapter in the South Korea/North Korea saga from the Elliott wave/socionomic perspective. Subscribe absolutely risk-free to Asian-Pacific Financial Forecast today and see the November issue for the latest KOSPI forecast.