Iraq could yet affect US stocks

By Peter V O'Brien

Friday 26th September 2003

Investors in major sharemarkets seem to have little concern about problems with economic and political matters.

Apart from the normal daily fluctuations when people get the jitters about the latest bleep on the information screens, there has been a steady rise in the main indices.

Attention has turned from war in Iraq, general political unrest in the Middle East and worries about where the next terrorist attack will occur.

Those matters could return to dominate investor thinking, particularly Iraq.

The war there was supposed to be over and is, as US military tradition understands the term, but American commanders have a poor historical record when faced with guerrilla warfare.

Iraq is dragging on. It seems more US troops have been killed or wounded since the war "ended" than while it was being fought.

The US involvement could yet have an effect on US stocks if casualties mount and forces might remain in occupation mode for a significant time.

Exchange rates have become an issue in recent weeks, particularly with Japanese attempts to weaken the yen and shore up the country's international trading competitiveness.

The sharemarket report for Tokyo last Monday said the Nikkei index had its biggest percentage drop for two years after the yen went up, affecting assessments of economic recovery.

The report was right, but the 4.24% market decline left the Nikkei at 10,475.10, still 22.1% higher than the 8578.95 at which it closed 2002.

Bond investors have done well this year as yields fell in line with low international rates, but they could be in for some capital values.

It is unusual for bond and shareholders to do well at the same time, but that view is based on historical trends, which may have stopped being self-fulfilling prophecies.

Changes to sharemarket indices always disguise price movements for particular stocks.

The table shows what happened to five US stocks between December 31 last year and September 19.

They were chosen at random, but with a view to giving a mix of industry activities. Many other combinations were available and would probably show similar variations in price performance.

The gains look good, but there are always potential fishhooks in investment, particularly when done between countries.

That brings us into the sphere of New Zealand institutions and individuals trying to cash in on US market recovery.

There is a problem with the exchange rate.

A fairsighted, shrewd New Zealand investor might have bought US stocks in December, on a hunch that prices would rise steadily this year.

The hunch was right, as shown in the table and market indices.

Unfortunately, the exchange rate against the New Zealand dollar went from US52.55c on December 31 to US59.2c on September 22.

A sensible institution would have hedged the currency factor.

There was a 13.3% currency appreciation in the period, so a New Zealand buyer of US stocks, transferring New Zealand dollars to US currency and being unhedged, would get less on realisation back to Kiwi money now.

Anyone buying US shares now at current exchange rates could get a twofold gain if prices continued to go up for, say, a year and our dollar declined against the American.

Such a strategy is risky in both aspects of the deal. It would need an unhedged currency play to come off for maximum gain in New Zealand dollar terms.

The maximum would also require solid gains in individual stocks as opposed to indices which represent market averages.

Percentage changes for the stocks in the table show the risk variation applicable to stock selection, adding to the risk of country and currency selections.

Making an investment dollar was never easy.

It is harder when juggling country factors, exchange rates and stock choices and could get very tough if international investors revert to an uneasy scepticism about world political and economic events.

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