Column: When the global economy seems to brush off big risks, prudence matters

An employee of a foreign exchange trading company in Tokyo works near monitors showing TV news on North Korea's nuclear test on Sept. 4, 2017. Photo by REUTERS/Issei Kato

August was another month during which asset markets continued to brush off the seemingly ubiquitous geopolitical and other risks facing the global economy. Many markets hit new highs, and virtually every downdraft was met with a wall of buyers eager to join the party. Japan registered phenomenal growth, China's economy seemed to be accelerating and many commodities (as well as shipping rates) pointed to a steady global economy.

Within America, the August jobs report, released on last Friday, captured the dynamic quite efficiently: an apparently disappointing jobs report was cheered by investors that felt the "weakness" may delay the Federal Reserve from raising rates or tightening monetary conditions. Many commentators suggested the employment slowdown was further evidence of a Goldilocks economy that was growing steadily without a noticeable risk of overheating.

READ MORE: Column: How can the stock market rally possibly continue?

But at the same time, the list of risks continues to grow and intensify, obviously led by North Korea, the rogue regime that has dramatically escalated tensions by firing a missile over Japan and detonating a hydrogen bomb. Disturbingly, North Korea's state news agency also warned that the weapon could be attached to a missile and "detonated even at high altitudes for super-powerful EMP attack."

An EMP attack is a risk I've previously discussed, and one that I specifically feared might even enter the North Korean arsenal of threats. For a sobering view as to how an EMP attack might impact the world, I'd encourage you to read the novel "One Second After."

Additionally this week, U.S. Secretary of Defense General James Mattis warned Kim Jong Un about the "many military options" available to the United States; the Chinese indicated that U.S. threats of halting trade with countries that do business with North Korea were unacceptable; and South Korea warned that North Korea is preparing to imminently launch a long-range ICBM.

And despite Dennis Rodman's praise of Kim Jong Un's forward-looking leadership approach, the Hermit Kingdom's recent actions suggest the threat is worth taking seriously.

Last month, I paid a visit to the NORAD Command Center and also went into Cheyenne Mountain Air Force Station, entering the bunker through two sets of 25-ton blast doors, designed to protect the facility from a nuclear bomb. I also had a chance to meet with the leadership team of NORAD at Peterson Air Force Base during a briefing with Gen. Lori Robinson, the four-star Air Force general running the place (and the highest ranking female service member in U.S. history), and her team.

Sure, asking the NORAD team what worries them is a bit like asking a gathering of hypochondriacs about their health, but I found it useful to hear what they chose to focus on. Unsurprisingly, North Korea was a top worry, but Robinson also expressed concern about the militarization of the Arctic, fiscal constraints, a resurgent Russia, an assertive China, Iran, natural disasters, space and cyber-related risks, and CBRN risks. Note that this briefing was before Hurricane Harvey dumped biblical amounts of rain onto the Houston area … or before the recent round of threat escalation from Pyongyang.

And lest you think this is a comprehensive risk list, a seemingly irrelevant mountain pass recently pushed India and China to the brink of war. Although three months of rising tensions appear to be resolved, the Doklam pass border dispute in the Himalayan mountains raised the possibility of a full-blown war between the two nations. Even if tensions have abated, I'm not convinced the risk of conflict is entirely gone.

Meanwhile, in Europe, last week's Brexit negotiations were grossly unproductive and suggested a very disruptive process. (To get a sense of how recent discussions have gone, read Politico's summary.) Bottom line: little, if any, progress has been made in recent negotiations, and worse, it seems a contentious process may be in the cards.

Risks are by definition probabilistic, and many never materialize. Nevertheless, rather than chasing returns, it may be prudent to forego gains if they are accompanied by elevated risks.

And within asset markets themselves, headline highs may be masking a shaky foundation. Market breadth, historically seen as a measure of market health, has gotten narrower and narrower, as fewer and fewer stocks are drive index performance. Weakness is brewing under the surface of market strength, which combined with elevated valuations, suggest a fragility to asset prices. While markets could of course go higher, headwinds are building as tailwinds dissipate.

So what is an investor to make of these dynamics? Those seeking to navigate the cross-currents of asset markets are certain to make errors. It's simply not possible to invest error-free. But it is possible to choose what type of error one makes, and in this regard, I'd suggest it's time to make errors of omission rather than errors of commission.

Risks are by definition probabilistic, and many never materialize. Nevertheless, rather than chasing returns, it may be prudent to forego gains if they are accompanied by elevated risks. While we can't know for certain which spark might ignite the tinderbox, Goldilocks appears to be playing with matches.

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