In recent months, the possibility of war with Iraq has often cast a pall over the stock market.
But if history is a guide, many fund managers and market strategists say, there is a good chance that the market will rally if hostilities begin -- and if the US prevails quickly. As a result, the first signs of conflict could be a buying opportunity.
"Those investors that are willing to go ahead and assume the risk that the conflict will be resolved satisfactorily will in all likelihood benefit from increasing their exposure to stocks," said John Lonski, chief economist at Moody's Investors Service. "But this calls for some investment fortitude. You're going against the market."
Even strategists who advocate that investors plan for war generally advise against short-term investments in military contractors and oil companies. While these areas may yield strong long-term returns, strategists and fund managers say that sectors like technology, transportation and some consumer staples are more likely to thrive in the short run.
There is broad agreement, however, that heightened geopolitical uncertainty will make it difficult for the market to sustain a broad upward move for long.
"The market will be very hard pressed to rally leading up to a war," said Jeffrey Kleintop, chief investment strategist for PNC Advisors, the wealth management division of PNC Financial Services, which is based in Pittsburgh.
Ample precedent is found for a strong rally once a war begins, Kleintop said. He noted that share prices declined in the weeks leading up to World War II, the Cuban missile crisis and the Persian Gulf war. The market rebounded once wars began, or, in the case of the missile crisis, the dispute ended peacefully.
In the months leading up to the gulf war, for example, the Standard & Poor's 500-stock index dropped more than 12 percent, to a low of 295.46 in October 1990. By the time the USW began its military campaign in January 1991, the index had climbed to 327.97; it would rise 28 percent over the next 12 months.
A prolonged or unresolved conflict could weigh on stocks. When the US invaded Afghanistan last fall, for example, stocks did not stage a sustained war-related rally.
Military contractors are not likely to benefit much from a short war because such a conflict would not increase their revenue substantially, said Jon B. Kutler, chairman and chief executive of Quarterdeck Investment Partners, an investment bank based in Los Angeles that focuses on military and aerospace companies. Still, he said, there is no doubt that military spending is on the uptick under President Bush.
While Kutler views the sector as a poor investment for the short term, he says it will perform well over a longer horizon.
"Wall Street tends to fall in and out of love with this sector, but I expect defense companies to post record profits these next few years," he said.
Similarly, Matthew Fruhan, manager of the US$305 million Fidelity Select Defense and Aerospace Portfolio, said. "It's clear that we're in the middle of a defense spending upcycle that began in the late 1990s."
His fund's top five holdings include Northrop Grumman, Lockheed Martin and Boeing, as well as the communications equipment makers L-3 Communications and Harris.
Andrew Pratt, who manages more than US$200 million in the Montgomery US Focus and Montgomery Growth funds, holds shares of Raytheon, which makes computer-guided weapons and surveillance equipment, and General Dynamics, a maker of military vehicles andadvanced communications systems.
"These are relatively inexpensive defense companies that I think will be beneficiaries of increased defense spending going forward," Pratt said.
Despite the creation of a Department of Homeland Security and worries about bioterrorism, Pratt is cool to stocks of biodefense and airport security companies. Many of these companies have yet to make a profit, he said.
The threat of war has contributed to the volatility of oil prices, which have fluctuated from about US$24 to US$30 a barrel since September. Investors with a strong stomach for risk could try to capitalize on a downward price movement by short-selling energy stocks.
These might include BP, Exxon Mobil and ChevronTexaco. Analysts say that if it becomes clear the US will attack Iraq, oil prices are likely to spike up. But if Iraq's vast oil reserves were opened to world markets, oil prices could plummet, and oil stocks would be expected to fall for the short term.
"Iraq has the second-largest known oil reserves in the world," said Philip J. Flynn, a senior market analyst at Alaron Trading, a brokerage firm in Chicago. "If you get a regime change and a friendlier government, the spigots will be opened and it'll be a lot harder for OPEC to control prices."
Still, short-selling -- betting on a decline in stock prices -- is always risky. If a stock rises, the losses can be greater than the original investment.
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