Investors worry about war

The chances of averting a new Gulf War appear to range from slim to none. President Bush has made it clear it would be diplomatically preferable to have the UN on side, but America will act unilaterally if need be.

So it appears the US will strike, one way or another. It’s just a matter of time.

What does this mean for investors? Let’s revisit what happened at the time of the first Gulf War.

Revisit Gulf War
Iraq began the hostilities on August 2, 1990 when it invaded Kuwait. Three days later, the first President Bush stated that the invasion “will not stand”, thereby setting into motion the US military build-up in the Persian Gulf.

Within a week, US Air Force fighters were landing at bases in Saudi Arabia. The build-up continued through the fall, as carriers moved into position and ground troops were flown to bases near Iraq.

On January 12, 1991, Congress passed a resolution authorizing the President to use force against Iraq. Five days later, we watched on CNN as Baghdad was bombed.

The war was on in earnest, but it didn’t last long. A cease-fire came into effect on February 28, and hostilities ceased wh Coalition forces clear victors, but Saddam Hussein still in power.

We’re now about to pay the price for that decision.

What markets did
Let’s look at what the markets were doing through all this, and how they responded to the war.

The US went into recession in mid-1990, just prior to the Iraqi invasion. However, the fact the country’s economy was contracting wasn’t clear at the time and the Dow Jones Industrial Average was on a roll, having risen almost 18 per cent between late January and July 16 to 17, when it closed both days just a shade under what was considered to be a 3,000 barrier.

At that point, what is now known as the Saddam Hussein bear market took hold. As war jitters grew and fears about Saddam’s weapons of mass destruction escalated, the Dow went into a nosedive.

Bear became bull
By mid-October, it had lost more than 600 points, a decline of 21 per cent. That officially categorized the slide as a bear market, the only one we were to experience through the decade of the ‘90s.

Then the Dow stabilized, and by year-end it had actually moved up more than 10 per cent from the October low. In mid-January, when it was apparent that Coalition forces were encountering little opposition, it went on a tear, rising more than 100 points on January 17, a huge gain by the standards of the day.

By the time the year was over, the Dow had risen 20 per cent from its level on January 1, had cracked through 3,000, and was on the road to what turned out to be the greatest bull market in history.

Compared to present
Now let’s superimpose this scenario over what we are currently experiencing. Today, we’re in a midst of a long bear market, far worse than the conditions that prevailed in 1990.

The war fever in Washington has spooked nervous investors even more. Once again, no one knows what kind of weaponry Saddam may have secreted away, and what potential damage he might do if and when war comes.

However, September 11 made us realize that the casualties may not be confined to the Persian Gulf this time around. Iraqi-sponsored terrorist attacks could come anywhere.

Next page: Down trend likely

Down trend likely
These conditions make it likely that the markets will continue to trend down in the coming weeks, as the war rhetoric escalates and the US pours more ships, planes, tanks, and combat forces into the region.

However, certain sectors of the market, such as oil stocks, should remain strong and may offer short-term profit opportunities.

How long this condition will last is unpredictable. But once hostilities begin, we should know fairly quickly whether to expect a repeat of the 1991 market recovery or a deepening of the malaise.

Depends on events
The key will lie in the speed at which events unfold. If it appears that Gulf War II will follow a pattern similar to that of the first incarnation, expect the markets to rally smartly.

In fact, it could mark the long-awaited end to this interminable bear. Oil prices will fall quickly in that situation, and so will energy stocks, so you’ll have to be nimble.

But if we see what amounts to a war of attrition, with no quick victory and a lot of collateral damage, then expect the markets to get worse before they get better.

The bear could continue until the second half of 2003, at least.

Other factors also
Of course, other factors will be coming into play as these events unfold: corporate earnings, economic data, consumer confidence, inventories, world trade figures, etc.

But it seems unlikely that, short of something dramatic, they are going to turn this market around. We may already be into a second Saddam Hussein bear market or, ironically, he could be the unwitting catalyst who finally pulls us out of our funk.

The bottom line is this: stay on top of developments and be ready to act quickly as the situation warrants.

Otherwise, sit in cash until the storm passes.

This article originally appeared in the Internet Wealth Builder.