Wartime Investing Is No Longer Simple

Times Staff Writer

Investing for wartime turned out to be a relatively simple matter during World War II: You bought stocks of the industrial companies that were helping to supply the military machine -- automakers such as Studebaker and Hudson, for example.

Later in the war, the importance of music and movies in maintaining morale on the homefront helped fuel shares of Decca Records and Universal Pictures, according to financial historian Richard Sylla of New York University.

The strategy of investing in war-effort suppliers such as steel and copper firms worked fine during the Korean War, too, as the Dow Jones industrial average rose about 36% from shortly after the conflict's start in mid-1950 to its end in mid-1953.

Since then, however, devising a wartime investment strategy has been a more complicated game for Wall Street, in large part because the two main conflicts -- the Vietnam War and the 1991 Persian Gulf War -- were historically unusual for their durations (the former very long, the latter very short).

Now, with war looming again, some investors have been trying to mine history for clues about how markets might fare, which industries and companies might benefit and which might be hurt.

But given the long buildup for an invasion of Iraq, many bets related to the expected conflict already have been placed -- and in some cases, perhaps played out. Defense stocks, for example, have mostly been sliding since mid-2002 after a two-year surge.

Today, with its overload of analysis, Wall Street is looking further ahead: Its concern is less with what will transpire in Iraq than with the outlook for the global economy once most of the shooting stops.

The focus is on whether and how consumers and businesses decide to spend money after they are no longer glued to their TV screens.

"You don't really look to invest for the war but for what happens after the war," said Sam Stovall, investment strategist at Standard & Poor's in New York.

That is why the leading stock groups in the rally of the last week -- which has lifted the Dow index 8.9%, including Tuesday's 52.31-point rise to 8,194.23 -- have been industries that are primarily bets on stronger economic growth, Stovall and other analysts say.

The stocks rising the fastest have been in such sectors as semiconductors, software and heavy industry. Some battered airline stocks also have begun to rebound.

"You're seeing a rotation into those sectors that typically do well in times of an economic recovery," Stovall said.

Of course, any bet on a healthier economy is inherently a bet that a U.S.-Iraq war will be over quickly, in lopsided favor of the United States and its allies, and without major damage to Iraq's oil fields. That is the assumption underlying the rally of the last week.

Investors' collective confidence approaching this war appears to be far greater than what they showed in advance of the 1991 Persian Gulf War. This time, the "postwar" stock rally already has begun. In 1991, the market didn't begin to surge decisively until the conflict was underway.

The confidence this time raises the risk to the market if the war doesn't go as well as expected, some warn. A terrorist attack on U.S. soil also could give some recent stock buyers second thoughts about maintaining an upbeat view.

Either way -- fast victory or unforeseen trouble -- investors primarily will be concerned with the potential effects on the struggling economy, experts say.

What happens with the price of oil will be key, many say.

"If oil goes back down to the mid-$20-a-barrel area that would be one of the best things we'd have going for us," said Jay Bryson, economist at Wachovia Corp. in Charlotte, N.C. The effect on business and consumer spending could be immediate, he said.

Sung Wohn Sohn, economist at Wells Fargo & Co. in Minneapolis, said Wall Street could become much more excited about businesses that would benefit most from a drop in oil prices. Those would include airlines, truckers, hotel companies and construction companies, he said.

On the flip side, some energy-related stocks -- which have mostly fallen since mid-2002 even as crude oil prices initially rocketed with the approach of war -- could be hurt if the oil-supply situation tilts much more in favor of consumers.

But Sohn said the biggest potential surprise after a war that goes well for the United States could be the effect on business capital spending.

Traveling to visit some of his bank's business clients in recent days, Sohn said he has been struck by how many foremen on the shop floors of industrial companies have told him they badly need to replace equipment, from ball bearings to computers.

"But they say that when they send their requests upstairs for approval, the chief executive or chief financial officer comes back and says, 'Can you wait another month?' " Sohn said.

"I think there's a lot of pent-up demand" for spending by businesses once the war is resolved, he said.

That could help many companies in the technology sector and in heavy-industry sectors such as machinery, analysts say.

Allan Rudnick, investment chief at money manager Kayne Anderson Rudnick Investment Management in Century City, said he has been adding to stakes in such companies as General Electric Co., DuPont and Intel Corp. on the expectation that "the next major industry sector to turn up will be capital spending."

To be sure, some investors still are busy trying to zero in on companies that will specifically benefit from defense spending or from a reconstruction of Iraq.

Engineering giant Fluor Corp. of Aliso Viejo saw the price of its shares reach $33.71 Monday, their highest since July.

"We already are beginning to witness a 'rebuild Iraq' theme play out in stocks such as Fluor and Caterpillar, which may spread to energy-equipment stocks as well," said Tobias Levkovich, investment strategist at brokerage Salomon Smith Barney in New York.

By contrast, shares of major defense contractors including General Dynamics Corp. and Northrop Grumman Corp., though getting a bounce in recent days, are sharply below their levels of last summer.

One risk for the defense sector is that Iraqi resistance could collapse in the first week of the campaign, said industry analyst Byron Callan at Merrill Lynch & Co. That could mean less demand for certain supplies.

Another risk, he said, is that the cost of occupying Iraq could rise so high in coming years that the government is forced to restrain other spending, such as on new defense projects.

It's the potential longer-term costs of the conflict that also trouble Ray Dalio, a principal at investment firm Bridgewater Associates in Wilton, Conn.

"Our concerns relate to what conflicts come next," said Dalio, referring to the risk of U.S. showdowns with countries such as North Korea. A continuing series of such events naturally could undermine investors' confidence in the future and thus reduce what they're willing to pay for stocks over time, even if business fundamentals improve.

"While there are some good reasons to be bullish and other good reasons to be bearish ... one wouldn't think that there is much doubt that this is a period of exceptional uncertainty," Dalio said.

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