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No end in sight for war-torn markets

As events in the Gulf prove the optimists wrong, Clare Francis asks how investors should react

Sunday 30 March 2003 02:00 BST
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With the war against Iraq in its second week, hopes of a short conflict have faded. And while ousting Saddam Hussein won't be as straightforward as many had anticipated, it is also becoming apparent that success in this war is unlikely to bring an end to the prolonged bear market.

As a result of the uncertainty after Iraq's invasion of Kuwait in 1990, stock markets around the world fell. But a sustained rally began once war broke out in January 2001.

A similar reaction had been expected this time round, and at first it looked as though history would indeed repeat itself. The news from Iraq was positive, with reports suggesting that the allied forces would reach Baghdad within three or four days. Markets rallied as a result, and the price of oil and gold fell.

All that changed last Monday after it became clear that US and British troops would face stiffer resistance than anticipated. Since then, there have been sporadic gains and falls, illustrating how finely balanced the global economy is and how easily certain news influences market movements.

And even if the Allies manage to achieve a crushing victory over Saddam's regime, too many other negative factors persist for there to be an imminent return to stock market stability.

"The consensus appears to be that the pattern of the early 1990s will repeat itself," says Mike Collins, head of asset allocation at Pictet Asset Management. "But this would be more convincing if the war parallels were matched by economic similarities. Ten years ago the US economy was emerging from recession, with low labour costs, low corporate debt and plenty of scope for inflation and bond yields to fall – perfect ingredients for a sustainable economic upswing. Today, however, balance sheets are over-leveraged, labour costs are high and interest rates very low."

While the outbreak of war has removed uncertainty to some extent, it has raised other questions, such as what will happen to post-war Iraq, how long Britain and the US will have to keep troops there, and what the financial impact on their economies will be.

To complicate matters, other economic problems are being sidelined due to events in the Gulf. One of the most serious is declining consumer confidence, which in the US has fallen to its lowest level since October 1993. If the situation doesn't improve, spending – which has been propping up the US economy – will decline and recession could follow. This, of course, is likely to have a knock-on effect in the UK, where consumer confidence has now hit a seven-year low.

The longer the war goes on, the longer a recovery in confidence is delayed. Jeremy Tigue, fund manager of Foreign & Colonial Investment Trust, believes that war gives people an excuse to do nothing – whether it's booking a holiday or moving house. And the longer hostilities last, the greater the impact of this procrastination.

On top of this, companies continue to issue profits warnings and further economic forecasts are expected to be revised downwards in the near future, so there is little to stimulate the markets.

"War may dominate our TV screens and newspapers, but for investors the market conditions are reminiscent not ne-cessarily of previous conflicts, but of previous bear markets," says John Hatherly, head of global analysis at M&G.

But Justin Urquhart Stewart, director at Seven Investment Management, urges investors not to be alarmed if stock markets continue to be volatile. "We could see the markets go up or down by 500 points but people shouldn't be surprised by that. At the moment, it's like a trampoline."

Even so, the case for having some equity exposure is still strong. If you're already invested, you shouldn't sell now unless you need to get hold of the money. "Is it worth letting short-term emotion guide you?" asks Frederic de Merode, portfolio strategist at Fidelity Investments. "It may be tempting to do something but it's important to remind yourself why you're invested."

And many fund managers believe that there are some good buying opportunities around at the moment. "Although I'm expecting low- digit growth for a few years to come, the relative valuation of many shares is attractive at the moment, so I'm a buyer rather than a seller," says Edward Bonham Carter, joint chief executive of Jupiter Asset Management and fund manager of its Undervalued Asset fund.

Active traders may want to take advantage of the skittish market conditions, hoping to buy in a trough and sell at a peak, though Graham Spooner, adviser at stockbroker The Share Centre, adds a note of caution. "We're emphasising the need to be very stock selective," he says. "Generally, we're advising not to chase the market at the moment because there's going to be so much volatility ahead."

For those taking a long-term view, putting money into equities on a monthly basis is probably a better option than investing a lump sum right now. "People who benefit from these short rallies are the frenetic anoraks who trade daily or those who drip-feed money monthly," says Mr Urquhart Stewart. "If you look five years ahead, markets will probably be higher. If you look two years ahead, markets will probably be higher. But next month – who knows?"

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