Market Review: What is war good for?

Thursday 3rd April 2003

The outbreak of war in Iraq saw extraordinary volatility in world markets. After three consecutive months of negative global equity market returns a (short-term) relief rally was always possible. However, it was surprising that equity markets started to rise before there was any clarity on how the campaign was likely to unfold.

Some of the euphoria around a quick resolution to the conflict was probably fuelled by some "bullish" comments from the Bush administration. "Weeks, rather than months", was one well-publicised quote from the American Vice-President. However, most wars take time and are seldom "clean" and this reality caused equity markets to drift back down by month's end.

Even the Gulf War in 1991 took 74 days, though most of us remember that as seeming to be over very quickly. Just as a company's CEO can have a key role in ensuring investor expectations are realistic, so it may have been better to "under promise and over deliver" when discussing the likely outcome of the war.

Currently, a key debate in financial markets is whether a victory by the US and its allies has the potential to lift slumping US consumer and business confidence. However, the longer the campaign, the less likely this is to occur. On the plus side a significant fall in oil prices and interest rates will have a stimulatory effect - the question being whether this will be sufficient to lift global growth.

The most likely outcome is the US economy "muddles" through, with GDP and corporate earnings growth being just "OK" but not exceptional. Such an outcome is not likely to fuel a major equity market rally, but neither is it likely to be a cause of further market collapses. Rather, we may see some consolidation in global equity markets, some of which are now looking much fairer value than was the case 2-3 years ago.

The US remains an exception to this with the market average P/E still at a relatively high level while its long-term outlook may also be impacted by the possible shrinking of the US economic "empire" globally. A major trend of the last 20-30 years has been the increasing influence of US multi-nationals on global culture, with younger generations seeing much of what comes out of the US (McDonalds, Coca Cola, Nike etc etc) as "cool".

Demographic trends of an aging developed world population and more youthful and consumer oriented developing countries have reinforced the need for multi-nationals to expand into new markets. A key long-term issue therefore is: will the youth in many of the emerging economies want to continue to consume products that are associated with the United States?

Another issue to consider is whether the war may be a catalyst for trade blocks to re-emerge. The split between the US/UK/Spain and France/Germany has the potential to result in less free trade globally. The US may be reinforcing this with it seeming to have an "us" (pro-war supporters) and "them" (countries against the war) attitude. Tony Blair, the UK Prime Minister, is a moderating influence on this but global growth prospects would be negatively impacted if this came to pass.

New Zealand trade flows would be negatively impacted by such an outcome and may be an economic cost of the Labour Government's anti-war stance. On the other hand our position in the world tourism market as a "clean and green" safe haven has probably been reinforced. This should also help to maintain strong permanent migration inflows into this country. With tourism and immigration key current influencers on last year's strong GDP profile of New Zealand, the outlook for this country in an "us" (pro-war) and "them" (anti-war) world environment may not be so bleak after all.

Looking back on March, most major equity markets were slightly down for the month and significantly down for the quarter. Despite being up 17% in a 7-day period in March, the UK FTSE 100 index was still down over 8% for the quarter. Likewise the Dow Jones index had one of its best weeks ever when war was announced and was up 1% for the month, although it still ended down 4% for the quarter. However, Germany (DAX) and France (CAC 40) took the "prize" for the worst performing of the major sharemarkets, being down 16% and 15% for the quarter, respectively.

The New Zealand dollar had a slight depreciation against most of our trading partners for the month, with the biggest fall of 1.7% being against the Euro. The Euro was the strongest major currency over the quarter, reaching all-time highs against a weakening US dollar.

Moving to bonds, March saw a partial reversal of recent strong bond markets. Although this had been mitigated by month's end, the domestic bond market produced a slight negative return for the month, while global bonds were up only slightly. Domestic and global bonds still produced strongly positive quarterly returns of 2.0% (CSFB Government Stock Index) and 2.5% (Lehman Global Aggregate Hedged Index) respectively.

Anthony Quirk is the managing director of Guardian Trust Funds Management

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