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WAR - Lucky Generals have a plan

Posted by: Brian Dennehy

 
Is the US likely to go to war?
 
According to people I listen to, who analyse this stuff for their day job, the answer is 'yes'.  It will result from the US deciding which is the lesser of two evils – a nuclear North Korea or another land war in Asia.  Plus, they won’t want to repeat the empty threats of Obama to Syria in 2012, after which a bad situation became extraordinarily worse.
 
You don't need to agree or disagree. You just need to understand how the markets are likely to respond if that happens, and plan your response now, while markets are relatively calm.
 
What happens when the US goes to war?
 
Broadly speaking the markets fall initially (with a considerable variation in size) while everyone figures out how bad it might be for the economy and company earnings and therefore the markets. Then they calm down, and 6 months later tend to be noticeably higher.
 
Why? Because, after a pause, the fact of the war creates certainty – in contrast it is uncertainty which the market loathes. Plus, the US is always fighting these wars in someone else's backyard - so how bad can it get? i.e. no invasion risk.
 
Inflation fears tend to rise because inflation rises, particularly due to supply shocks.  Plus, government spending will tend to rise.  Both of these are negative for bonds.
 
That’s a broad-brush picture of how history informs us.
 
What about now?
 
No two periods are the same. The current extreme over- valuation of the US stock market creates a unique vulnerability right now. We have referred to the US market as resembling the avalanche-prone snowy slope. The final snow flake that will trigger the avalanche could come at any time, and in any shape. 
 
Moreover, on our analysis the US market has moved from being extremely over-valued to being a dangerous bubble, as we discussed in Boom Bubble Bust Part II.  History suggests the downside is 50%+ - but tells us nothing of when that might happen.
 
Two questions. Is any war on its own likely to trigger falls that great? No one knows. It is possible but doesn't feel likely. More likely it will be a wake-up call, as a result of which some will be scared off, but the market will edge to new highs within 6 months (suggests history, and the gut feel of experience).
 
Second question, how should you respond to war? With a steady hand is the short answer, and with a clear plan.
 
For example, in last week’s blog When should investors sell?, we highlighted that Warren Buffett’s first rule of investing is not to lose money. His second rule is do not forget the first rule!
 
A straightforward tool to have in your plan is a stop-loss.  Sell your funds when the price falls by a certain percentage e.g. 10%.
 
There is much more on this in the new blog Stop-losses – reducing losses AND boosting growth
 
You will get the chance to discuss this and much more in live teleconferences in coming months.  Watch this space.
 
FURTHER READING

Topic: Market commentary


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