This is MoneyClub

Stocks for the Long Run
Part 3: HOW THE ECONMIC ENVIRONMENT IMPACTS STOCKS

Chapter 13 Chapter Guide

Prelude

WHAT MOVES THE MARKET?

1. UNCERTAINTY AND THE MARKET
2. DEMOCRATS AND REPUBLICANS
3. STOCKS AND WAR
   -The World Wars
   -Post 1945 Conflicts

CONCLUSION

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Chapter 13 Chapter Takeaways

Prelude
-On 9/11, S&P futures plunged about 3 percent, indicating nearly $300b would have been wiped off of US stock values if markets had been opened. They were closed for the week but the German DAX fell over 9%. London also suffered. The Pound and the Euro rallied against the dollar with the US’ new vulnerability. When the NYSE opened on Sept 17, the Dow fell 7.13%, and closed the week down 14% from Sept 10.

WHAT MOVES THE MARKET?
-However, many moves arent accompanied by news at all. Since 1885, there have been 126 days when the DJIA changed by 5% or more. However only 30 of those can be explained with a world political/economic event (Data provided). Monetary policy is the biggest driver. The 22.6% one day fall on Oct 19, 1987 is not associated with any identifiable news event.
-Even when news has occurred, there can be sharp disagreement over what news caused the market change. On Nov 15 1991 when the Dow fell 4%, headlines in Investor’s BUsiness Daily read “Dow Plunges 120 in a Scary Stock Sell-off: Biotechs, Programs, Expiration, and Congress get the Blame”. the FT read “Wall Street Drops 120 Points on Concern at Russian Moves”.

1. UNCERTAINTY AND THE MARKET
   -The markets hate uncertainty. Eg post Sept 11: How big a hit would the $600b tourist industry take?. Presidents are one source. Eisenhower’s heart attack – 6.54% decline. JFK – 2.9% decline before NYSE shutdown for 2 days, and 4.5% increased when LBJ took over.
2. DEMOCRATS AND REPUBLICANS
   -The markets prefer republicans to democrats. However the stock market has actualy done better under Democrats than Republicans. The greatest bear market occurred under Herbert Hoover (R), and the greatest bom under FDR (D). Yet since 1888, the market fell avg 0.5% following a Democratic victory, but rose 0.7% following a Republican victory, though this effect has muted since WW2.
   -The returns in a third year of a presidential term are clearly the best. The fourth is not.
   -Since 1888, the market has fared better in nominal terms under Democrats than Republicans, but since inflation has been lower when Republicans held ofice, real stock returns have been slightly higher under Republicans than Democrats, though this has not been true the past 60 years when the market performed far better under Democrats on real and nominal terms.
3. STOCKS AND WAR
   -Since 1885, the US economy has been involved in a war about 1/5th of its time. Inflation averaged 6% during wartime and less than 2% during peacetime while stocks perform nominally equally.
   -Stocks have actually been more volatile during peacetime than during war. Theory indictes that war should be profoundly negative on stock prices due to government interventions.
   -The World Wars
   – The market rose nearly 100% during early WW1, then fell 40% when the US became involved and rallied when it ended. WW1 was far more volatile than WW2. When Austria-Hungary declared war on Serbia on July 28 1914, the markets remained closed until December 12. Illegal trading continued outside NYSE with prices 15-20% below the July close. But Traders soon realised that the US would benefit from the rise in demand for munitions and raw materials, and when the NYSE reopened the Dow rose 5% higher. 1915 is the best single year increase in the Dow, up 82%. Stocks fell 10% when the US entered the war on APril 16 1917.
   –Traders learnt this lesson in WW2 – When Great Britain declared war on Germany on Sept 3 1939, a buying panic caused the Dow to gain 7%. This faded as FDR imposed an excess profits tax on corporations during wartime. On Pearl Harbor, the Dow was down 25% from its 1939 high and after PH it fell 3.5%. By the time Germany surrendered in May 7 1945 the Dow were 20% above the prewar level. The detonation of the atomic bomb over Hiroshima caused stocks to surge 1.7%.

   -Post 1945 Conflicts
   –The Korean War – Jun 25, 1950, the Dow fell 4.65%, > Pearl Harbor fall because it took markets by surprised. The Vietnam War – the Dow climbed 18% over the first 1.5 years, but fell 30% when the Fed moved to curb inflation in the following months. Markets then recovered, but when Nixon sent troops into Cambodia, the market fell again. The 1991 Gulf War – Oct 11, Dow slumped 18% with oil price news and a US recession. After the US joined the Gulf War on Jan 17, stocks soared 4.4% on Jan 18, Dow ending 18% higher on Feb 28 when the war ended. War on Terrorism – Dow down 16% by Sept 21 but rebounded on the Afghanistani offensive. Because of the success of the Afghanistani war and aggresive Fed policies, the Dow rose 26.3% FROM sEPT 21 TO dEC 28. From the end of March 2003, the first month of the Iraq invasion thru June 2007, the annual return on the market was an extremely srong 17.5% per year.

CONCLUSION
-When investigating the causes of major market movements, it is sobering to realize that less than one in four can be linked to a news event of major economic or political import. This confirms the unpredictability of the market and the difficulty in forecasting market moves. Those who sold in panic at the outbreak of World War 1 missed out on 1915, the best year ever in the stock market. But those who bought at the onset of WW2, believing there would be a replay of WW1 gains, were disappointed because of the government’s determination to cap wartime profits. World events may shock the market in the short run, but thankfully they have proven unable to dent the long-term returns that have become characteristic of stocks over the long run.