Markets test war principle that what goes down must eventually come back up

When a case of anthrax was discovered in Florida last week, stock prices fell on Wall Street. When a report determined it was from natural rather than terrorist causes, share values rose again. When this was contradicted, the markets oscillated once more.

Stocks dipped on reports from Congress that there was a 100 per cent chance of terrorist retaliation if the US initiated an attack on Afghanistan. They rose again when President George W Bush pressed Congress for speedy approval of a federal rescue package.

Every alarmist news bulletin frightens investors in these edgy days. There were market ripples over the alleged hijacking of an Indian airliner and the downing of a Russian airliner. Every policy pronouncement from Washington can send share values up or down. Short-term volatility has reached an "incredible" level in the words of one experienced asset manager.

The launching of missile strikes against Afghan targets has brought new uncertaintly to the markets. On Monday, when investors would normally be looking at company reports to determine the rhythms of the trading session, they were instead watching geopolitical developments. The business TV channels, CNBC, CNNfn and Bloomberg, interrupted market coverage for press briefings from Washington - and turned to unlikely sources for guidance.

These are the "formers", out-of-office politicians and generals who pontificate on television. Now that the US is at war, buy and sell decisions are being influenced heavily by commentaries from intelligence and military experts like former Secretary of State Henry Kissinger who is suddenly in great corporate demand and former national security adviser Sandy Berger who was recurited by Lehman Brothers to brief investors. In all the confusion, with investment firms trying to manage a portfolio around bomb damage assessments or the prospect of new terrorist acts, many asset managers are looking to history as their best guide. And they are finding some comfort there.

The markets follow certain patterns at time of war. When the US gets involved in armed conflict, the markets almost always go into an immediate sharp decline. A period of volatility follows which soon gives way to recovery, with share values bouncing back to higher levels than before.

War establishes the principle on Wall Street of what goes down must come up, according to a survey by Ned Davis Research, which looked at how shares fared in the 126 days trading following 28 American crises since 1940.

When the Korean war started in mid-1950, shares first sank 12 per cent then gained 19.2 per cent. Market indices fell 1.9 per cent when the US invaded Panama in 1989, then rose 8 per cent. The Dow lost 4.3 per cent in the first weeks of the Gulf War in early 1991 then gained 18.7 per cent.

The principle does not always hold true. Shares did not recover from a modest fall in the same timeframe after US marines stormed ashore in Grenada in 1983, but this may be the exception that proves the rule, or maybe it was not important enough to be considered a real war.

Will this time be any different? The pattern has up to now followed historical precedent. Shares fell through the floor in the first trading week after the September 11th attacks. The record 14 per cent fall was followed by a 10 per cent recovery.

But one must enter caveats before concluding that 126 days after the attacks the indices will be higher then before. Market history shows the rise in share values tends to coincide with growing confidence in victory. But this war against terrorism is being waged against an ephemeral enemy. There is no prospect of capitulation by a defeated enemy force to mark its ending. This is going to be a long and uncertain conflict.

There are other unique elements to be factored in. For the first time since Pearl Harbour, the war is being waged in part on US territory and people are fearful for their safety in their own cities. The economy is being pulled down by fear of flying, choked borders and massive job losses from an already gathering recession. But there is a huge amount of pent-up stimulus in the economy in the form of a series of aggressive rate reductions, tax cuts and federal rescue packages, all of which could act as a catalyst for a turnaround in mid 2002 according to the US Economic Cycle Research Institute.

All it needs perhaps is for the US consumer, who drives two-thirds of the world's biggest economy, to get out of the bunker and head for the malls again to prove to market sceptics what Oliver Wendell Holmes once said:"A page of history is worth a volume of logic".