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Rob Carrick

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Best plans for the worst case

Rob Carrick

TORONTO (GlobeinvestorGOLD)—All the optimistic talk about stock markets withstanding the assault of a war in Iraq is probably right on the money.

Just take a look at those long-term graphs of stock market performance that mutual fund companies are always passing out. They show the long upward trend of the major indexes, with fleeting downward blips for all the armed conflicts that have taken place over the decades. The key message: Wars have the same lasting impact on the markets as yesterday's weather.

But what if it's different this time? With the threat of terrorism adding a whole new dimension to the risk of war, you can't brush aside the possibility that the stock markets will be part of a Middle Eastern war's collateral damage.

Let's be pessimists for a moment and look at what might happen in a doomsday scenario where a war leads to major terrorist assaults on the United States, or its assets worldwide.

Economic growth could sputter out throughout the world, interest rates could fall and the stock markets could do likewise. Think stocks have gone as low as they can go after a three-year bear market? Actually, they could fall a fair bit further and still not be out of line with historical price-earnings ratios.

S&P 500 Energy Index vs. S&P/TSX Cdn. Energy Index (1 year chart)You'll often hear investing pundits talk about which stock sectors to play in the event of a war in the Middle East, notably defense companies or those in the oil sector. But if the war-induced market pall is long and severe enough, it's doubtful even these sectors will offer much shelter. Remember, if things get bad enough, a recession or even a depression is possible.

Investing in this environment would be hazardous to say the least. So what do you do?

The best defense

If you're in the mood to play some offense amid the uncertainty, try precious metals funds or gold stocks. Gold is the ultimate hedge against global turmoil, of course. No matter what happens, gold has value.

Cash and cash equivalents would be appealing as well. As bad as things might get, it's hard to imagine Government of Canada treasury bills losing their value. Same would go for Canada Savings Bonds, which offer great liquidity, Rock-of-Gibraltar solidity and a pitiful payout of 2 per cent this year.

Money market funds would be an option as well, the plus here being that they're ubiquitous and virtually risk-free as long as the economy has not crumbled to a point where blue-chip companies and governments can't keep up with their short-term borrowings. Keep in mind, though, that if rates were to fall, so would the yields on money market funds. The annual return right now on these funds is close to 2 per cent, so there's not a lot of fat there.

Another safe and easy choice for the risk-averse is to hold money as cash in a brokerage account. You can instantly deploy this cash back into the market when you're ready, but in the meantime you'll be making 0.25 per cent interest, or more if you have larger balances.

Bonds vs. stocks

U.S. Treasury bonds would be a global investing refuge of choice, but Canadian government bonds would offer reasonable stability combined with a higher yield (rates are higher in Canada than in the United States).

If you want to speculate on stocks in war-ravaged market, the sectors of choice would include consumer staples and possibly companies in the tobacco and medical supply areas. Defense stocks commonly mentioned as being Iraq war plays include Raytheon, a leading missile producer; Boeing, maker of military helicopters and planes; and, General Dynamics, the company behind the U.S. military's M1 Abrams tank.

Remember that we've been playing pessimist here. Most likely, a war would be swiftly concluded and not especially disruptive. This is worth remembering if you've a mind to war-proof your portfolio.

Rob Carrick has been writing about personal finance, business and economics for more than 12 years.

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