The Winning War Investments

by Dr. Steve Sjuggerud

The Winning War Investments

By Dr. Steve Sjuggerud, President, Investment U

Monday, February 24, 2003: Issue #216

"Nothing is more troubling to financial markets than uncertainty And nothing creates more uncertainty than War, the most unpredictable of all human activities." -John Steele Gordon, The Great Game

Last night's "Grammy Awards" ceremony was almost watchable. Real talent was rewarded. People that have spent every waking moment studying to become great singers/songwriters - such as 23-year-old Norah Jones, last night's big winner - received proper recognition for their remarkable accomplishments.

But as I watched the broadcast, it dawned on me that neither Donald Rumsfeld nor Colin Powell won a single Grammy last night

"I think we're all in agreeance that this war should go away as soon as possible." -- Hard Rocker Fred Durst of Limp Bizkit fame, during last night's "Grammy Awards."

So why is it that Donald Rumsfeld and Colin Powell didn't win any "Grammy Awards" last night? Probably because - unlike the John Mayers and James Taylors of the world - they don't have any idea how to write a song. They haven't devoted their lives to this craft, as these entertainers have. Rumsfeld and Powell have devoted their lives to something else, and they have reached the top of their fields.

Nobody asks entertainers for their opinions about Rumsfeld's job, or Colin Powell's job. This is also for good reason. They also have no right to judge. They have not spent their entire careers in the military, and they are completely unqualified to have any useful opinion. Not to mention - as in the case of Fred Durst - many of them are not even qualified to speak the English language. ("Agreeance.")

I guess Rumsfeld understands this. I didn't see his Grammy opinions. But entertainers don't seem to understand this. We hear their uninformed opinions about the job of Messrs. Rumsfeld and Powell all the time.

I am not qualified to render an opinion about the near-certain war either. All I know is that my father was a career military man, a Naval Academy graduate who was a pilot in Vietnam. All I believe is, that if the men in charge have the military training and military-instilled integrity that my father has (which they do), these men will do the right thing.

What Happens To Stock Markets After National Security Is Threatened

I do feel I'm qualified to comment on what might happen to investments in the case of war. On September 12, 2001, a day after The Day, I issued a report to my readers titled: What Happens to Stock Markets After National Security Is Threatened.

Here are a few of the basic conclusions:

1. Stock markets fall at first, in shock, and mass uncertainty sets in.

2. The uncertainty is resolved, and stock markets roar higher than where they began.

Markets bounce back from financial crises, and they actually do so with remarkable gusto. The pattern is this: There's a sell-off as the news breaks, followed by a (generally short) period of uncertainty, and then (generally) a remarkable rally as the uncertainty is removed.

Let's hope this time is no different than the others - a short period of uncertainty followed by a remarkable rally after the uncertainty is removed. (In my September 2001 report, by the way, I showed every threat to national security since WWI and how they affected on the stock market.)

Ultimately, buying after the period of mass uncertainty and around the time that some resolution of the uncertainty appears imminent has traditionally been an excellent way to make money in stocks.

That covers stock markets but what about oil?

How Oil Prices React To Threats To National Security

When national security is threatened, history suggests that oil prices only rise if the opponents pose a threat to the world supply of oil.

During the Korean War, oil prices fell in inflation adjusted terms. During the year of the Cuban Missile Crisis, oil prices once again fell adjusted for inflation. And as we steadily became more involved in Vietnam, you guessed it oil prices fell from 1965-1972 adjusted for inflation. In these situations, the oil supply was not at risk. So if the world supply of oil is not at risk, the price of oil is not at risk.

However, if the world oil supply is perceived to be at risk, oil prices will rise. During the Iran/Iraq conflicts of 1978-1980, oil prices more than doubled from $14 a barrel in 1978 to $35 in 1980. Also, oil prices spiked significantly higher when Iraq invaded Kuwait in 1990. But prices then quickly subsided to two-decade lows in 1994.

So, based on limited evidence, it seems clear that oil prices rise when the supply of oil is threatened in particular, not our national security.

Beyond Oil - What Else Has Value In Times Of Crisis?

The best-known commodity/store of value during times of crisis is traditionally considered to be gold. There are multiple reasons for this. First, countries traditionally print money wildly during wars to "finance" the war, making the paper currency less valuable. And second, brutally, if a country no longer exists one day, what are pieces of paper backed by its government worth? Not much.

However, proving mathematically - not just anecdotally - that gold is a good store of value is hard to do. Its price has been controlled for nearly as long as data has been kept. But gold is always in demand in crisis.

While the price of gold was controlled, the price of another commodity, wheat, was not. If you were to look at a chart of the price of wheat adjusted for inflation, you would see a spike in price during the wars - which shows the government printing of money at the time. Commodities - if they're good for anything - are a good crisis hedge.

If you are a speculator, you may want to be ready to buy stocks aggressively once the U.S. has dealt a decisive military blow. Just hold the whole market in an index fund like that offered by Vanguard or an exchange-traded fund (ETF).

Stock markets hate uncertainty. The unseating of Saddam Hussein would likely be seen as a removal of a major uncertainty, and could send stocks higher. A resolution in North Korea could do the same.

As for me, I'm not changing things too much. I'm not a short-term speculator. Stocks, on the whole, are still expensive. I can't tell you how big the "war rally" will be. Or how long it will last. While commodity prices are likely to rise and stocks will likely also rally as the news improves on Iraq and North Korea (based on what stocks have done throughout history), I can't advise jumping in with both feet.

Good investing,

Steve

Today's Investment U Crib Sheet

  • I used last night's "Grammy Awards" as a means for illustrating an important point today. Be sure, when listening to someone - either for investment advice or any other kind of advice - that the person you're listening to is actually qualified to speak on the topic. As the United States moves closer to military action, there are bound to be a number of "experts" hitting the airwaves with ideas on what you should do with your money. Just make sure - before acting on any advice - that the expert has more experience as an investor than Donald Rumsfeld does as a musician.

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