The longer answer was, "of course, that's shot from the hip," an attempt to crystallize a complicated set of possibilities into a short phrase and single event. The bottom might not be the exact day we go in. And, we might not even go in. There's still a possibility of a coup or a resignation, for instance.
Yet until events align so as to make invasion a near certainty, or unnecessary, there will be a drag on world markets. This is both a psychological phenomenon, and what economists call a "real" one, about which, more below. The time to be bullish, my advice ran, will be more or less the day that uncertainty is swept away. In fact, it is likely to be exactly that day and minute, regardless of the fact that everyone knows this and will try to anticipate it.
My colleague, who shall remain nameless, strongly agreed with my analysis. He even defended our view against a skeptical third party, also a substantial investor, against a devil's advocate argument from the efficient markets school, which believes that markets ingeniously anticipate such factors in an almost perfect way. A detailed review of events during the Gulf War under President George H.W. Bush, my like-minded colleague noted, shows that the U.S. and other markets bottomed on the exact day before the U.S. invasion. Similar market trends emerge from World Wars I and II and Korea. Even the Vietnam War, while impossible to date in such a fashion given its vague start and finish, was characterized by frequent market rallies that coincided with U.S. bombing strikes.
Even so, this pattern of history repeating, and repeating, and yes repeating, is something of a paradox. If we assume people who buy and sell stocks and other financial instruments are rational, thoughtful, and like to make money, we would also expect people to be able to see past the temporary dips. It seems clear (all three of us agreed) that the U.S. and world markets are almost certain to be higher three to six months from now than they are today and probably substantially higher.
Thus, investors should be able to look past the coming weeks of worry, to "invest over" the short term to make money in the long. This is not because investors are saints, or even geniuses, but because they are people of common sense, and are greedy, in the good sense of wanting to make money for their clients. Yet, seemingly, they can't. Just as investors during the Gulf War of 1991 couldn't see over the hump, based on what they knew from market movements in previous wars, so they seem unable to do so today.
Why is this? And, can we therefore make money off the fact that history not only repeats, but for markets, seems to be something investors seem condemned not to fully learn from?
There are, at seems to me, at least three answers, one theoretical, one practical, and one having to do with this particular war. If one is right, it should be possible to invest through the invasion of Iraq, and if two or three are, it should be very possible.
1. Markets are not rational.
That is to say, people are governed by logic, but also emotion, extrapolation bias, and other such phenomena. Ask people to estimate the product 1x5x10x100 and you will invariably get a higher answer than if they are asked to estimate the product 100x10x5x1. Even if people were rational, information is not perfect and rational, and projections about the future are even more tenuous. Hence, markets are governed by constant imperfection and regular excess, the near opposite of the smooth, nearly perfect equilibrium that exists on the chalkboard.
If markets were perfectly rational, it would be impossible for investors to out-perform the market, and highly unlikely that some would under-perform the market, except in the case of gross incompetence. Yet both occur. (There are a small number of investors who regularly enjoy double or triple the market average, and, as well, about 90 percent of investors who under-perform, year after year.) Maybe that is why many of the best investors of the last 1,000 years, from Cosimo de Medici and Voltaire to George Soros and Julian Robertson, were not particularly devoted to efficient-markets thinking, at least as far as they managed money.
2. The future is even less rational.
On a more practical level, the future is the future, inherently uncertain. As Yogi Berra put it, it ain't over 'til it's over.
However certain a U.S. invasion (or, possibly, regime change without it) appears now, there are a thousand non-invasion "risks," one might say, that could intervene. Even the chronic delays in invasion matter: There is a big difference, in terms of likely U.S. markets and economic performance, whether we are certain Bush will invade tomorrow, or in early March, or "sometime in his first term." This goes to the third factor, and the one, in my opinion, that is most important.
3. War (and in this case, the prospect of war) has "real effects."
This latter fact may be the pre-eminent one driving U.S. stocks lower in recent months. It isn't just that investors, looking at companies, must quite rationally worry about all the possibilities and uncertainties likely to intrude, from if there is a war to how it will go. It's the fact that company managers, as they make daily decisions about hiring and firing, investing and not investing, look at the situation with Iraq, and must make a decision on a third level: waiting or not waiting.
Thinking about investing and business matters was probably much more clear when people used phrases like "the political economy" and even "animal spirits." Right now, there is a global economic wait. Perhaps it is poetic that this is how the U.N. Security Council is proceeding: waiting to see if Bush and America will wait, waiting to see what Iraq will do if the United Nations and the United States wait, and waiting to judge the results of waiting.
In any case, when businessmen and people wait, risk and profits and gains and losses, activity in general, is moved back by a quarter or two at a time. This means that objective economic conditions stagnate. Not that they significantly worsen: The U.S. economy is growing, slowly, and likely to grow faster in the months to come. But, matters stall. Multiply this by investors waiting to see results, and politicians waiting to act, and you have the new "www," which is to say, the "world wide wait."
There is empirical evidence for this view in market movements over the last half year. Note that the repeated downdrafts in stocks in recent days extend back not just to early January, but to last July, when the long "shadow war" against Iraq began. In that time, corporate earnings have improved, the economy has grown, albeit slowly, and President Bush has shown some fairly bold and effective leadership on a number of fronts, but most distinctly on Iraq. Yet markets are off.
This is not to say that economic or corporate or political conditions have radically improved. But have they honestly gotten 10 percent or 20 percent worse, as the movement in United States and other world equities over the last 6 to 7 months would imply? This can hardly be the case.
The bottom line is, we're short the U.S. and especially European markets in the near term, using leverage, via short term options that expire in February or March. At the same time, we're almost fully invested (without leverage) for the future, with a special concentration in markets such as Russia, Indonesia, Turkey, and Israel that will respond well to continued high energy prices, or that have already nearly fully discounted the war, and will benefit disproportionately from its execution.
We're also short markets (such as South Korea) that will not only not benefit immediately from the war, but may in fact come under increased pressure as the Bush administration moves past one dictator with weapons of mass destruction, and deals with others.
On the day the United States invades Iraq (or its practical equivalent), we'll go aggressively long, remain short Korea and take profits in Russia. It's remarkable that money can be made on such a seemingly obvious strategy. Then again, some of the reasons it is likely to work are not obvious.
Perhaps the fundamental reason one can use such common-sense strategies is that most investors are elites, and many elites are hypnotized by their own cleverness, by their ability to see past obvious truths and believe in clever half truths and outright falsehoods. "If you can see through everything," as C.S. Lewis put it, "you can't see anything."
At the end of the day, though, for investors, it doesn't really matter why, it just matters what. Yes, it's amazing that investing on the repetition of history works. It's also amazing, however, that people fail to take advantage of it. Hold your short-term puts, buy on the coming dips, and be fully long the day of a U.S. invasion or regime change in Iraq. History repeating itself may be an avoidable tragedy, but it's also a very good investment bet.
(Gregory Fossedal is chief investment officer of the Democratic Century Fund, managed by the Emerging Markets Group, dcfund.net. His firm may hold some of the securities mentioned in "The Bottom Line." Individual investors should contact their own professional adviser before making any decisions to buy or sell these or any related securities.)
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