Markets and crises: A history lesson

NEW YORK, Oct. 22 - It’s an old chestnut: Stock markets hate uncertainty, and the uncertainty of the outcome of the conflict with Iraq is certainly contributing to the weakness in the stock market. But throughout the last 100 years, the markets have reacted differently to wars and other crises.

THE 20TH CENTURY has seen its share of big shocks and crises, including World War I, the Great Depression, Pearl Harbor and World War II, the Korean War, the Cuban missile crisis, the Kennedy assassination, Watergate, the Gulf War, the Oklahoma City bombing, the World Trade Center bombing in 1993 and the Sept. 11 terrorist attacks.

Through it all, there has been the stock market, reacting to each of these crises, but as market historians note, each in a different way.

Take wars, for example. Are they good or bad for the stock market?

“What you see going into wars is that any uncertainty or saber rattling causes the market to go down,” says Jeff Hirsch, who edits “Stock Trader’s Almanac.” “Once something decisive happens, Wall Street gets comfortable that things will be resolved, prices tend to go up.”

A BANNER YEAR

In World War I, the stock market closed for four months as the war began in 1914. When it reopened, the Dow Jones industrial average was down about 30 percent. But the war ended a recession that began in 1913, and 1915 turned out to be a banner year, with the Dow up over 80 percent.

“Nineteen-fifteen turned out to be the best year in the history of the Dow in percentage terms because the U.S. and brokers figured out how much they were going to make from war contracts,” says John Steele Gordon, who wrote “The Great Game: The Emergence of Wall Street as a Great Power.” “Companies like Bethlehem Steel went up 400 percent in one year.”

When the United States entered the war in 1917, the markets dipped again, and then again later in 1917 during the Bolshevik revolution in Russia. But the markets already were recovering by the time the war ended in late 1918.

When World War II broke out in 1939, the markets were still recovering from the Great Depression, but shortly after the Germans took Paris in the middle of 1940, market sentiment soured. The Dow dropped about 20 percent.

The Dow dropped 3.5 percent on the first trading day after the attack on Pearl Harbor and was still down nearly 10 percent six months later. But that was the bottom, and the huge war effort began moving the markets up.

SMOOTH SAILING

“The market hit its lows in the spring of ’42, a few months after Pearl Harbor, and after that it was clear sailing for the stock market,” says Roger Ibbotson, a market historian and professor at the Yale School of Management.

But the two world wars were major global events, and in both cases helped pull the United States out of economic slumps. Those economic rebounds — combined with victory in both wars — helped the market rally. But few events, even sudden shocking events, can reverse the underlying economic trends and their effect on the stock market.

“The economic trends are going to guide where the stock market is going in the long run,” says Ibbotson. “A shock is going to affect a day or a month but it is not necessarily going to affect the longer term.”

Take the Kennedy assassination. The market dropped nearly 3 percent on the day of the assassination. But the economy was in the middle of a multi-year expansion, so six months after the assassination, the Dow was up 12 percent.

Or take the resignation of Richard Nixon in 1974. The market dropped about 1.5 percent the next trading day. You would think clearing up the uncertainty would rally the markets, but an overriding economic weakness continued to weigh on the markets.

SLIDING INTO A FUNK

“The economy was slipping into the funk of 1973-74, a major recession, a deep one, and economics govern the market,” says John Prestbo of Dow Jones Indexes. “And so all this sideshow about Watergate was maybe a little bit of uncertainty on the political side, but the economics of the day took the markets where it needed to go, down.”

And when Iraq invaded Kuwait in August 1990, the market dropped 6% in three days. But it began rallying in October, as the United States was gearing up for operation Desert Storm and investors believed the economic climate might improve. It continued rallying into the Gulf War in January 1991.

Even the World Trade Center bombing in 1993 and the Oklahoma City bombing in 1995 didn’t stop the Dow from advancing. It was taking its cue from the continuing economic expansion.

In the week and a half following last year’s terrorist attacks, the Dow dropped 14%, but then rallied as investors believed the attack created bargains because the economy would soon improve. That assumption proved to be mistaken.

QUESTION OF THE DAY

And what about the current conflict with Iraq?

“I think the market is pricing in an invasion right now, and I think it’s pretty well discounted at this point,” says Prestbo.

But the uncertainty of the outcome still weights on the markets.

“If it’s swift, the Iraqi government collapses and the military refuses to follow orders, I think you’ll see a boom in the stock market,” says Gordon, the author. “If it turns out to be a protracted struggle in the streets of Baghdad, then you’ll see a real bear market.”