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Michael Den Tandt

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The long run

Michael Den Tandt

TORONTO (GlobeinvestorGOLD)—The stock market, like the investors whose mindset it reflects, is sometimes prone to wishful thinking. That's never been more evident than in the past few weeks, when each daily blip in the geopolitical picture has caused a corresponding lurch in the major averages, up or down depending on whether the news seemed to make war more immediate, or less.

It seems many professional investors, plagued by an inability to forecast corporate earnings or economic data this year, or trust predictions by the usual suspects on Wall and Main streets, have resorted to the worst kind of short-termism. Never mind what the stock market, or gold, or the price of oil, is likely to do over the next six months, one year, two years; what's it going to do in the next week? Two weeks? Then they buy or sell accordingly.

For investors, this is the worst kind of foolishness. As regards geopolitics, there's only one thing we need to know: U.S. President George Bush and British Prime Minister Tony Blair have staked their political futures on toppling Iraqi dictator Saddam Hussein. The only way that's likely to happen is by armed invasion. When that armed invasion occurs, the stock market will fall, probably sharply, and the prices of bullion and crude oil will soar. The severity of these moves will correspond directly to the duration and severity of the conflict. Period.

Does Iraq's decision to begin destroying its stockpile of Al-Samoud 2 missiles make war less likely? No, it does not. Does the Turkish parliament's stunning decision to prevent a U.S. invasion from its soil, even at the price of losing a $30-billion (U.S.) aid package, make war less likely? No, it does not. Does the capture of Khalid Sheik Mohammed, one of the most senior Al Quaeda figures, make war less likely? Again, no.

These are episodic developments in the current strategic environment. They change nothing except at the level of tactics.

This is not to say the Turkish decision, if it holds up under intense U.S. pressure, is trivial. On the contrary, it could be critical. But it makes the crisis more dangerous, not less. It could make the war longer, not shorter. It could increase the casualties and costs for both sides, not decrease them. As such, this news was not cause for a rally, but rather a decline. And yet, in the early part of the trading session following the Turkish decision, stocks rallied, and sharply at that.

Wishful thinking, indeed.

Now, the bulls have some potent ammunition in their arsenal. First, they point to the first Persian Gulf War, in 1990-91. Saddam's legions invaded Kuwait in August of 1990. That prompted a 13-per-cent decline by the Standard & Poors 500 index over the following three months. Then markets went sideways for a couple of months, until January 17, the first day of the American counterattack.

The S&P 500 rose 4 per cent that day, and 12 per cent by the time the war ended on the last day of February. The price of oil, meantime, peaked on Sept. 28, 1990, at $39.51 (U.S.) a barrel. By the first weeks of January, 1991, it had already collapsed back into the low twenties. It then proceeded to decline, with a few briefs interruptions, for most of the 1990s, until it bottomed late in 1998 in the $12 range. Meantime, peace and freer trade had broken out all over the world, contributing to the greatest bull market in the history of the planet.

Likewise, one can look beyond the Gulf War, to just about every other political or economic crisis in recent times, and find reasons for optimism.

Same thing only different

At the outset of the Korean War, in 1950, the S&P 500 dropped 15 per cent in five weeks, according to data provided by Strategic Nova Mutual Funds. One year later the index was up more than 30 per cent. At the height of the Watergate scandal in 1974, the S&P 500 dropped nearly 20 per cent in five weeks. A year later, it bounced 27 per cent. During the worst of the Asian currency crisis in 1998, stocks dropped more than 10 per cent in a month. Twelve months later, they'd risen nearly 20 per cent.

Terrific. There are just two wee problems.

First, the current crisis is not a replay of the Gulf War. In fact, just about everything but the Middle Eastern country involved, and the family name of the U.S. president, are different.

In the Gulf War, the Arab world was terrified of Saddam and firmly onside. This time it's not. In the Gulf War, Europe was a staunch ally. This time it's not. In the Gulf War, there was ample excess oil production capacity. This time, thanks partly to the Venezuelan crisis, there isn't. In the Gulf War, Saddam had plenty incentive to avoid using chemical or biological weapons. This time, facing invasion or death, he doesn't. In the Gulf War, Israel was governed by a relatively compliant regime. This time it isn't. In the Gulf War, there was no threat of terrorist counterattack on U.S. soil. This time there is.

As for the historical stats, they are indeed comforting, except for one very troubling anomaly. In ten major world crises since 1950, nine have seen the markets rise sharply in the year following. But in the tenth crisis, the S&P 500, after dropping 17 per cent in nine weeks or so, continued to slump. A year later, it was down 28 per cent. That was the Arab oil embargo in October, 1973. We don't face an oil embargo, at least we don't think we do, not yet. But we do face, arguably, a protracted period of high energy prices. We also face continuing protectionism in the United States, and rising trans-Atlantic trade tensions, exacerbated by disagreements over the fate of Iraq.

Even in the best-case scenario, where Saddam is forced into exile at the eleventh hour by enterprising souls within his top ranks, any geopolitical relief rally could be short-lived. That's because the Bush Doctrine of pre-emptive warfare doesn't allow for any ending. After Iraq, there's North Korea. After that, there's Iran. The turmoil could last for years.

If that's true, it makes sense to invest defensively. It makes sense to buy high-dividend yielding stocks, utilities, companies with no economic sensitivity. It makes sense to seek stocks trading at less than their book value. It makes sense to avoid bellwether technology stocks generally, because the group's multiples are still far higher than they should be, based on previous market lows. And it makes sense to have some exposure to energy, gold, bonds, and cash.

As much as we may want the good old days to come back, we're not there yet. Not by a long shot.

Michael Den Tandt joined The Globe and Mail is a member of The Globe and Mail's editorial board.

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