Ieodo is a manmade platform affixed to an undersea rock (named Socotra) in the Yellow Sea. […] The platform is Korean, and the facility is an oceanographic research station. South Korea built the platform and claims jurisdiction, but China claims jurisdiction, too. […]

Ieodo is situated in the area where South Korea, China and Japan are engaged in asserting claims over Air Defense Identification Zones (ADIZ). […] Civilian aircraft and unarmed military or research aircraft face the choice of lengthening routes to bypass the zones or acknowledging them by advance filing of flight plans with the respective governments.

And those governments face similar choices. Do they respect the zone of another country with which they disagree and file their own flight plans? Or do they ignore the claim of another country, which they contest, and thereby add to the risk of confrontation? Thus we have a geopolitical test of wills at work in East Asia.

The initial US response to competing claims was to support Japan and fly two B-52s into the zone the Chinese claim, without notifying China. That move ratcheted up the Chinese response, and the Chinese scrambled fighter escorts. The incident triggered more responses and drew Korea into the kerfuffle.

The latest news suggests that Japan is willing to engage in discussions with China and Korea. This may lead to a negotiated settlement, but that is doubtful. Meanwhile, North Korea’s petulant young leader is again starting to activate his nuclear ambitions. […]

What does this mean for markets?

Four reserve currencies matter worldwide. They are the euro, the pound, the yen, and the US dollar. Two of the countries that preside over them are involved in this dispute, and China is aspiring to world reserve currency status. While the Eurozone and UK are primarily observers in the dispute, each has its own financial and economic problems. There is rising geopolitical risk when the three largest economies in the world are involved and two (soon to be three) key world reserve currencies are involved.

For investors today, the fraught political situation requires vigilance and a contingency plan. We would not sell securities in anticipation of a future additional military confrontation. We would however carefully observe all actions taking place in this East Asian kerfuffle. We would act very quickly were there a ratcheting up of additional activities. […] There will be a test of wills, skills and the ability to patrol airspace. These tests will be negotiated with swiftness and technological capacity that many of us in the civilian arena can only read about and attempt to understand.

Our current market position of overweighting Japan, looking for the yen to weaken, and looking for the Japanese stock market to rise is the best course to stay on. We are on that course. Our portfolios at Cumberland Advisors in the international arena are positioned accordingly and have been for some time. As of today, there is no change.

In the US, the stock market reflects an upward bias as long as the Federal Reserve’s policy continues along the present lines. We do not expect Chair Yellen, the new Fed Board of Governors or the Federal Open Market Committee to make any abrupt, shock-inducing policy changes. It is not in the Fed’s best interest or the nation’s best interest to do so, and policymakers know it. The onset of predictable Fed tapering is not a policy shock if it is transparent and undertaken gradually.

The unknown element here is China. We do not know how far Chinese leadership is willing to go to assert their claims. We will get mixed messages purposefully sent to us by the leaders in Beijing. Remember, it is the mixed message that puts the other side on a risk-aversion course. North Korea, for its part, is unpredictable.

Who’d a thunk it? Ieodo and Socotra Rock are now the center of an East Asian kerfuffle.

The preceding is an abridged commentary by David Kotok of Cumberland Advisors and has been reposted with permission of the author. The commentary is available in its entirety at http://www.cumber.com/commentary.aspx?file=120813.asp.

The ideas and opinions expressed in this blog are those of the author and they should not be perceived as investment advice or as any other kind of advice.