What we can learn from legacy of war; Quick victories can be good for

Stock markets continued to gyrate last week as the threat of war with Iraq seemed a certainty. But will a short, sharp victory set the value of our pensions and savings bouncing up again - or are wars not always as good for share prices as we are led to believe?

History would teach us that brief conflicts where the victor is never in doubt can - after initial dips before the fighting starts - be good for markets. Share prices rallied quickly during the 1991 Gulf war and the recent Afghan conflict, for example.

The violence of recent share price plunges, however, seems to be telling us that our problems could be far from over with a quick victory in Baghdad.

Markets seem to be signalling a growing realisation that smashing up Iraq will not end political uncertainty in the Middle East. No one knows how Iraq's near neighbours Iran, Syria and Saudi Arabia will respond, and what will happen to oil prices; nor where the war on terrorism will go from there.

The US's war on terrorism, of which the proposed attack on Iraq is a key part, has already had a dramatic effect on share prices in the UK. Since September 11, 2001, when the White House was spurred into action by the attacks on the World Trade Centre (WTC) and the Pentagon, the FTSE index of Britain's leading shares has fallen 31%. This has wiped nearly a third off the value of many people's pensions, mortgage endowments and other savings.

Overall share prices have fallen by around half since the index peaked at 6930 on December 30 1999, having already slipped 27% before the murderous planes took off on September 11. Though the market was due a correction, there can be little doubt the attacks set them plunging again - and to surprising depths.

Such dramatic falls in the value of pensions and other investments could cause acute pain to anyone retiring in the next couple of years. They could also bring grief to those with investments they needed to cash in order to repay a homeloan or meet some other major expenditure, such as education bills. Such investments may only mature at half what the investor has planned on. And no one can accurately predict when their value will begin to climb again.

The problem is it is not clear what kind of war the US and its British ally are engaged in, as President Bush himself acknowledged in an address to the American people shortly after the twin towers of the WTC collapsed He said: "This will be a different kind of conflict against a different kind of enemy. This is a conflict without battlefields or beachheads, a conflict with opponents who believe they are invisible. Yet they are mistaken.

"Those who make war against the United States have chosen their own destruction. Victory against terrorism will not take place in a single battle, but in a series of decisive actions against terrorist organisations and those who harbour and support them."

It has been clear from the outset, then, that the US's wider war on terrorism is a campaign that could go on indefinitely; fought against a constantly updated gallery of shadowy opponents.

From a stock market perspective this could be bad news indeed. Despite what the pundits tell you, when you look at the figures closely it is clear that long, drawn-out and unresolved conflicts are not good for share prices.

Share prices plunged dramatically during the first world war and only recovered again in the 1920s. Similarly, they tumbled during the second world war and kept falling throughout until victory became certain.

Vietnam was similarly a disaster for markets. The S&P 500 index barely moved, from 82 to just 87, in the 11 years between the signing of the Gulf of Tonkin Resolution in 1964 - which brought the US into the war - and the fall of Saigon in 1975.

It is the threat of a similarly long, drawn-out affair that is causing concern today. Even the Vatican recently warned that: "The gravest consequence of a war against Iraq, would be a flare-up of terrorism against the United States and against allied Western countries."

On the other hand, as far as investors are concerned, it could be said that the problems of war provide an escape from the problems of peace.

We have recently witnessed a 17-year bull market, which began in January 1983, when the FTSE stood at 860. By the time it peaked at the end of 1999 our wealth had grown by 706%. Some correction, followed by a period of nervousness was inevitable, particularly given episodes like the Enron scandal, which called into question the probity of those in charge of large corporations.

How short-lived these reversals might have been in other circumstances, we will never know. But, again, the lessons of history are not encouraging. On the face of it, losses were recouped in just two years after markets crashed of 1987, and again in three years after the 1973-74 tumble. However, this encouraging picture should be treated with caution as both were periods of high inflation - which masked the true pain. In fact, after adjusting for inflation, it took investors more than eight years to recoup their 1973-74 bear market losses.

Even grimmer is the slow painful recovery after the stock market crash of 1929, when it took 25 years for shares to regain their former peak. There had, though, been a major war in the interim, when the UK economy was tightly controlled - indeed virtually nationalised - and even the US had strict laws preventing "profiteering".

How long recovery will take this time depends on where you stand on the optimistic/pessimistic scale, but there are some fairly gloomy predictions around.

Stock market historian David Schwarz says it is almost impossible to gauge where the market will go from here, but he does point out that after a bubble, confidence normally remains badly shaken for several years.

He argues: "If you look at the charts, when the UK stock market rises continually for 15 years, UK investors lose money for the next 15 years."

In his view, the market will not go anywhere for the next 10 years and if investors are thinking about getting back in, his advice is: don't. "We may be somewhere near the bottom of the current sell-off, but that doesn't mean we're headed for a new run. There will be short- lived rallies followed by setbacks, where some people will make money by buying and selling the right stocks at the right time. But I think overall the next decade will be a long plateau," he adds.

London Business School academics Elroy Dimson, Paul Marsh and Mike Staunton, are not far away from this view. They believe the footsie has a 50% chance of breaking through its all time high by 2013, and a 50% chance that the breakthrough will come later.

Justin Urquhart Stewart of Seven Investment Management is also nervous. "We have no idea what the impact of a war with Iraq will be," he says. "There is no clarity. Will the region become destabilised? And what will happen to the oil price?

"But the market concerns aren't just about the war. Company margins are being squeezed, consumer spending is slowing, government borrowing may have to increase to pay for the war - bringing the threat of higher interest rates.

"There will be technical rallies where people who know what they are doing will make money, but this is not a market for the novice investor."

Jeremy Batstone of NatWest Securities, owned by Royal Bank, is more cheerful, though.

"We will see some recovery in corporate health," he says. "What we want now is a short, sharp timescale to get things moving.

"I'm not too pessimistic, because no matter how bad things get they can only get better. If they got very bad, it would be worse for other countries and force the likes of Japan and Germany to face up to some harsh lessons. And that would be good for us all."

Copyright 2003 SMG Sunday Newspapers Ltd.
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