War and Markets: Stack's Outlook

02/21/2003 12:00 am EST

Focus:

James Stack

President, Stack Financial Management

"We make war that we may live in peace," said Aristotle.  And for better or worse, that justification has been used for two millennia since the philosopher spoke those words. Another aspect of war that has not changed is the uncertainty that it engenders. Few investors or businesses can look ahead without considering the ramifications of a war with Iraq and possible terrorist attacks. Jim Stack has analyzed previous war periods and the impact they had on the financial markets.

Perhaps no advisor has a better handle on historical financial trends than Jim Stack, who follows scores of technical and fundamental indicators covering the market's past and present trends, in order to forecast future activity. His in-depth market skills have led to an exceptional long-term record. Stack was bullish throughout the bull market of the 1990s and presciently turned bearish near the market peak in 2000. He has correctly remained cautious since then, although he maintains limited positions in value oriented stocks that he feels will perform well despite a poor economy. His latest historical study helps us put the impact of war on the financial markets in better historical perspective. Says Stack:

"The critical component that’s missing in today’s market is confidence, both consumer and business confidence. And a recovery can’t occur without it. People are clearly holding their breath, waiting for the next shoe to drop. Will it come from the dollar, Iraq, or terrorism? From the fragile economy to geopolitical tensions, it’s taking a toll on confidence. For a clue to the answer, let’s take a look at history.Over the last 60 years, the stock market has confronted the prospect of war at least five times. Often, there’s an immediate, short-term negative response when the news is released. That suggests a correlation between public anxiety and the impact on Wall Street.

WWII: In March of 1938, Germany invaded Austria. Wall Street had been in a bear market for over a year when the news broke, and the S&P 500 dropped another 19.9% over the two-week period after the surprise news. But then it rebounded and gained 62% over the next 7 months. Pearl Harbor, another surprise event, drew the US into the war in 1941. Again, the S&P 500 was already in a bear market–the second in five years. Following Japan’s attack on the US, the index fell 10.9% in 22 days. However, the market hit a final bottom less than five months later and embarked on a four-year bull market that would carry it to a new high and leave the residual effects of the Great Depression behind.

Korean War: In June of 1950, President Truman committed US troops following the invasion of South Korea. At the time, Wall Street was enjoying a healthy bull market. To understand public sentiment from that period, we dusted off our 50-year library of US News & World Report . Other than voicing concern over the growing communist presence worldwide, there was little hint of pending trouble in Korea. Indeed, investors were once again caught off guard at the news of war. In the four weeks following the announcement, the S&P 500 fell 12.9%. Then it took off and nearly tripled before the end of the bull market cycle six years later.

Vietnam War: In August 1964, US naval ships were attacked in the Gulf of Tonkin. Although Congressional action marked our ‘official’ entry into war, Vietnam was already a topic of media headlines leading up to the incident. On Wall Street, the market had been in a steady uptrend since 1962 and formalizing US military action in Vietnam led to a dip of only 2.2% in the S&P 500 over the next four weeks. Since the news came as no surprise, there was virtually no short-term impact and the bull market continued until 1966.

Persian Gulf War: Iraq’s invasion of Kuwait in August of 1990 shocked investors, and by October the S&P 500 had dropped 14%. October, however, marked the bottom for the market. As the 1990 recession took hold, investors remained nervous through mid-January while the US military prepared for the launch of Desert Storm. On January 16, the official announcement of Desert Storm brought an immediate market response. The S&P 500 gained 3.7% the first day and had climbed 16.7% one month later. That was the beginning of the big bull market of the 1990s.

Today: It’s evident from these examples that war news can impact the market, particularly when it comes as a surprise. However, in none of these examples, could a severe or ongoing bear market be attributed to the war. Today’s picture is clouded somewhat by the fact that we are on the back side of a popped bubble. And, unlike most wars, the Iraqi conflict is widely expected. In other words, there will be no surprise unless it erupts into a regional war. Nonetheless, it is coming at a critical time for the market, which has not established a definite trend over the past six months. The market currently looks like it is base-building, yet it could still go either way as tensions resolve and the real economic strength (or weakness) becomes evident.

"Historically, a war or conflict does not cause a bear market. More often than not, it tends to lead to firm or rising stock prices as confidence and patriotism rebound. This review allows us to put current events into perspective. A conflict in Iraq may create anxiety and raise investor nervousness, but by itself, such an event is not a compelling reason to abandon the stock market. It’s probable that a quick resolution, or even decisive action, in Iraq will have a positive effect on Wall Street. As such, we plan to maintain our defensive allocation in value stocks."

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