Jumping the gun?

By ANDREW OXLADE, COLUMNIST
Updated: 19:00 EST, 18 March 2003

STOCK market pundits claim that once the bombs begin falling, shares start rising. The theory is that the first signs of trouble scare off investors, but then once battle is underway hopes that a solution is in sight restores confidence.

For months, some experts have been predicting that the FTSE All-Share will replicate the fall and recovery seen during the Gulf War in 1990. Shares plunged after Iraq invaded Kuwait in August 1990. They then began a gradual recovery in the two months before the Allied forces retaliated in January. Once the attack was fully underway, the index leapt 21% in two months.

So conventional wisdom has it that the same will happen this time. The bulls appeared to have jumped the gun, with the FTSE 100 posting its biggest ever three-day gain - around 11% - to the close on Monday.

However, this pre-emptive strike by investors holds dangers. If the market has been religiously clinging to the notion that markets will rise on the invasion then maybe that hope is already

factored into share prices. In that case, market sentiment might not be at the bombed-out levels some experts would have us believe.

Secondly, no two political situations are ever the same. Iraq was the clear aggressor in 1990, so there was unilateral support for the subsequent Allied assault. With most of the world pitted against Iraq - and with a clear aim to only throw Saddam Hussein out of Kuwait - investors could see it would be a quick war.

This time, the US lacks the support of the United Nations and may also incur a fierce backlash from the Muslim world. Plus plucking Saddam from Baghdad is far more difficult than the goals of last time.

The Gulf War aside, pundits recycle the notion that stock markets always rise on war. David Schwarz, a stock market historian, has often repeated this mantra. 'Maybe I shouldn't make my statement so strongly,' he admits. 'It doesn't happen every time but there's plenty of occasions when it has.'

He believes the recent rise is the beginnings of a more enduring rally. 'There's more to come if history is anything to go by,' he adds.

However, past performance can easily be twisted. Barclays Private Clients gave up on its research into the effect of war on stock markets. 'We looked at it and couldn't find any real pattern,' says Hilary Cook, director of investment strategy. 'There are similarities between the stock market now and the last Gulf War. The rally now as then is in expectation of a quick war. But there are bigger risks this time round.'

Conflicts involving the US over the past century show stock markets generally fall on the outbreak of hostilities and then rise. New York's Dow Jones index rose 30% on average during the first 18 months of 20th Century wars, according to MarketHistory.com, a research firm.

Consider the Second World War. Schwarz says the UK stock market fell 13% in August and September 1939 after Britain declared war on Germany, but then reclaimed those losses in the following six months. He says there was a similar pattern with the Korean War (1950-53) - the market fell and then rallied. But it only rose 3% in 1951 and fell 6% in 1952.

The rally only gathered real pace after the war in 1953, when UK shares rose 18%, and in 1954, when they rocketed 42%. But this was also when rationing ended sparking a retail boom, and when share-ownership blossomed in popularity. The war was just one of several factors driving markets.

But there is also evidence that if war drags on, thereby draining government finances, then shares fall. The US market fell 2% during the

prolonged Vietnam War (1964-75), according to Dow Jones. The two years after it ended were among the best on record.

More recently, Argentina's invasion of the Falklands in 1982 triggered a 5% fall in the FTSE All-Share. It bounced back 10% during the fighting and then rallied another 15% in the six months after the cease-fire.

While markets seeem to rise during short conflicts, there is no guarantee that pattern will be repeated this time. There is also a chance that the forthcoming battle could be drawn out.

Investors may want to focus on other factors. 'Stock markets are merely a reflection on the growth of company profits,' says Barclays' Cook. 'Investors chase it up and down in the short term, but profits are the long-term driving force.'

It is impossible to accurately forecast the effect of a conflict on the stock market. No two wars are the same. Investors do know that global economic health drives company profits and, therefore, share prices. War may affect that health but long-term investors would be better served focusing on the wider economic picture.

Even historian Schwarz remains gloomy on the long-term outlook for the stock market.

• Chartists, who study past performance to forecast future share movements, have suggested any rally needs to take the FTSE 100 above 4197 points - the level it repeatedly failed to break in autumn - to sustain a further bounce from there. That's 11% higher than its current level of around 3810.