War vs Sensex

What would be the impact of war on the economy and the stock markets (which is a good indicator of the economy)? During robust economic growths, the stock markets post handsome gains. Whereas, during sluggish growth and uncertain economic future, the stock markets tend to remain volatile (i.e. the current situation). They are always looking for triggers and good news to trickle so that the markets can build on their gains. However, at present all we can hear of is the possibility of a long drawn US-Iraq war. Experts believe that a short war with Iraq could give the much-needed fillip to the lagging stock markets all around the world. However, at the same time, they are concerned of the consequences and the effects of a long drawn war on the world economies. Investors are concerned of the future of the economy and the effect of continued strength in oil prices. During times of such uncertainty, it is very difficult for an investor to take a view on his investment avenues, including stock markets.

Have you ever wondered what happens to the stock markets during and after the war? The fact is that the stock markets do tank for sure when anything untoward or devastating incident takes place or is about to happen. But, at the same time, it is also (generally) true that the market players take this fall in the markets as the best time to buy into equities.

What has been observed in the last few wars/conflicts is that the stock markets lose ground before the action, but then bounce back smartly over a period of time. However, not always. The above table shows the stock market returns over various time periods post the conflicts. It can be seen that after the Gulf War started (it lasted for 43 days), the sensex gained 2% within a month from the date of commencement of the war. The gains increased further over a period of time as can be seen in the table and after a year, the sensex had gained 97%!

Somewhat similar was the story after the WTC attacks. After 1 month of WTC attacks, though the sensex was lower by 6%, it bounced back and at the end of 3 months was higher by 12% over Sept 11, 2001 closing. However, the story changed from there onwards and the markets world over began to lose ground due to the uncertainty over the growth prospects of their economies. The situation reversed this time and the sensex was down marginally by 1% after a year of the WTC attacks.

An investor should look at the above numbers and derive his own conclusions. It has been a mixed picture so far. Major world indices ended the year 2002 on losses (third year in a row). However, our sensex managed to buck the trend and register gains of 4% in the same period. So what should an investor do? Of course, any prudent investor would naturally play a balancing game in his portfolio, consisting of both - equities and debt. However, though the war/conflict may create volatility in the markets in the short-term, but for the long term, fall in markets provide an opportunity to build up portfolios by picking up fundamentally sound stocks at attractive valuations.