Rule Breaker Portfolio If War Comes

War in Iraq appears likely. Rather than worry or flee the stock market, 20th century history indicates that war represents a stock-buying opportunity.

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By Jeff Fischer (TMF Jeff)
January 21, 2003

As thousands of troops sail to the Persian Gulf, you can feel the energy of potential conflict building. By month's end, the U.N. will discuss its initial report on Iraq's weapons status, and President Bush will give his State of the Union address. By February, war could begin, with or without the U.N.'s blessing.

Not only does war affect us as world citizens, it affects how many of us are thinking about the stock market. Hey, why wouldn't it? The uncertainty surrounding war has always brought increased market volatility.

Some investors are swearing off stocks, citing the likelihood for war, so today we have a message that needs emphasizing: War has not, in the past, dampened the stock market for long, if at all. As with other crises, the stock market rebounded from the adversity of war to rise again.

There's a reason for this. More than anything else, the stock market tracks the U.S. economy and the earnings power of U.S. companies. Everything else in the interim is a mere storm -- storms do buffet prices, blowing them down at times, or lifting them too high other times, but these storms are always temporary. Just remember this: The stock market's long-term direction has always reverted to following the economy and its earnings power.

If you nail that sentence onto your computer monitor, you might: (1) need a new computer monitor, and (2) view falling share prices due to external factors, including war, as buying opportunities rather than a cause for panic.

Unfortunately, there are plenty of wars in history that teach this lesson. If you had bought stock at the outset of any major war in the past 90 years, you could have achieved above-average returns, and often in short order.

WWI
The First World War took everyone by surprise. An act of terrorism quickly snowballed into a war that nobody wanted. Ferdinand's assassination on June 28, 1914, led to stunning war declarations across Europe by Aug. 12.

Given how quickly the world went from relative peace to all-out war, you'd expect the U.S. market to fall. And it did. From a Yale study (S&P numbers are from Jan.-to-Jan.), here's how the S&P Composite Stock Price Index performed:

Year     S&P      Return
1914     8.37       N/A             
1915     7.48      -10%     
1916     9.33      +25%
1917     9.57       +3%  
1918     7.21      -25%
1919 7.85 +9%
1920 8.83 +12%

In the year after war broke out, the index fell more than 10%. The next year, though, stocks rose to new highs, up 25%. If you'd bought during the bad news early in the war, you saw strong gains. (And these numbers don't include a hefty 5% annual dividend.)

The years following the end of WWI, stocks gained 9% and 12%. Then in the 1920s, of course, the market soared.

WWII
The U.S. stock market declined 17% in the five months following Pearl Harbor, most of in December. Had you bought soon after the attack -- as the U.S. entered the war -- you would have gained 13% from Jan. 1942 to Jan. 1943, and you would have seen your investment more than double by 1946. Granted, that's largely because the war was won. But again the outbreak of war represented a low point for stocks. (For the record, the U.S. spent more than $2 trillion in current dollars on WWII.)

Year      S&P      Return
1941     10.55       N/A      
1942      8.93      -15%  
1943     10.09      +13%        
1944     11.85      +17%   
1945     13.49      +14%      
1946     18.02      +33%

Korean War
The day after North Korea invaded South Korea in 1950, the S&P 500 declined 5.3%. You can see below that this decline in 1950 (not even noticeable in these numbers) was another buying opportunity. The U.S. stock market rose steadily during the war, and it more than doubled in the next five years.

Year      S&P      Return
1949     15.36       N/A
1950     16.88       +9%    
1951     21.21      +26%         
1952     24.19      +14%
1953     26.18       +9%      
1954     25.46       -3%     
1955     35.60      +40%

Vietnam War
The longest war in U.S. history, with combat from 1965 to 1973, was one to which we were slowest to commit. Given that it lasted so long, we're stretching ourselves to tie any stock market moves to it. So we won't. We'll just share the numbers.

Year      S&P
1964     76.45                  
1965     86.12
1966     93.32  
1967     84.45  
1968     95.04 
1969    102.04    
1970     90.31                
1971     93.49
1972    103.30                 
1973    118.42        

There was a 55% cumulative gain during the war, excluding dividends. You know what happened after the war -- the bear market of 1974. Again, probably not much relation. (Financially, Vietnam cost the U.S. an estimated $110 billion to $150 billion, or over $400 billion adjusted to today.)

Gulf War
Saddam invaded Kuwait in Aug. 1990. The U.S. stock market declined 13% the next three months -- presenting another buying opportunity. The U.S. attacked Iraqi forces on Jan. 15, 1991. By Feb. 13, as victory was apparent, the S&P had gained 16%, and was above its Aug. 1990 level. From Jan. 1991 to Jan. 1992, the market gained 28%.

Year      S&P       Return
1989     285.41       N/A
1990     339.97      +19%
1991     325.50       -4%   
1992     416.08      +28% 
The financial cost of Desert Storm was an estimated $60 billion (more than $80 billion today). The estimated financial cost of invading Iraq today: approximately $100 billion. Rebuilding it: at least another $50 billion. That sounds like a lot, but per capita it isn't. We should note, too, that 88% of the cost of 1991's war was reimbursed to the U.S. by the alliance coalition. This time? Who knows. At any rate, the figures aren't large enough to hit the U.S. economy.

Steps to Take
As a rule, you shouldn't own stock that you're not planning to hold for at least five years. If this is the case in your household, then you shouldn't worry about external factors that might weigh on your stocks the next few years, war or not. Obviously, history isn't a predictor. But if history is a guide, war is not a killer of stock markets.

So, you might dislike war, but you needn't let it cloud your investment thinking.

  • Focus on company financials, not on the media machine.

  • Only buy companies you're comfortable owning.

  • If you have money you want to invest, create a list of potential buys.

  • View market declines that are based on external events as buying opportunities.

  • If you're still nervous and want to talk to an advisor about your financial plan, the Fool can link you with an unbiased advisor through TMF Money Advisor.

  • Finally, try to keep a light heart -- war is as old as man; we wish all war would end, but so far, that appears unlikely.

Over and out.

Jeff Fischer didn't mention the possibility of "mass destruction" warfare, because if it happens, nobody will care much about stocks. The Fool has a conventional disclosure policy.


Rule Breaker Portfolio Returns as of 1/17/03 Market Close (closed 1/20/03):

            RB        S&P     S&P 500
            Port      500      DA*    Nasdaq
Week       -2.07%    -2.64%    --     -4.83%
Month       8.62%     2.50%    --      3.05%
Year 8.62% 2.50% -- 3.05%
CAGR
using IRR** since 8/4/94*** 21.52% 8.33% 10.09% 7.95%
10/20/98*** 1.40% -3.91% -3.41% -5.34%

*Dividends added. Or, danger ahead. Whatever.

**Compound Annual Growth Rate using Internal Rate of Return. This performance measure is more meaningful than total return because we began adding cash occasionally in July 2001. In a total return calculation, or ((Current Value - All Cash Deposited)/All Cash Deposited), cash added would show up as returns. And that wouldn't be cricket!

***What's this? The Rule Breaker Portfolio's precursor, the Fool Portfolio, was born Aug. 4, 1994. In a 10/20/98 column, David Gardner announced the name change of the Fool Portfolio to the Rule Breaker Portfolio. Here we provide returns as if the RB Port started on either date. Remember, don't mimic any online portfolio. Most individual investors should restrict any positions as risky as these to under 20% of their portfolio -- and could have a long and happy investing life with 0%.

Rule Breaker Portfolio

  Ticker Company Price
 Change
 Daily Price
 % Change
 Price 
  AMZN AMAZON.COM, INC. (0.32) (1.5%) 21.08 
  AOL AOL TIME WARNER INC. (0.46) (3.11%) 14.35 
  TREE LENDINGTREE INC 0.17 1.20% 14.37 
  EBAY EBAY INC 0.91 1.22% 75.76 
  MLNM MILLENNIUM PHARMACEUTICALS INC (0.22) (2.62%) 8.18 
 SHORT  SIRI SIRIUS SATELLITE RADIO INC 0.01 0.94% 1.18 
  SBUX STARBUCKS CORP (0.29) (1.44%) 19.80 
  AMGN AMGEN INC (0.45) (0.88%) 50.87 
 SHORT  GTRC GUITAR CENTER INC (0.35) (1.78%) 19.28 
  SPY SPDR TRUST;1 (1.41) (1.56%) 89.25 
      
  Trade Date # Shares Ticker Cost/Share Price  Total % Ret  
 09/09/97 1320 AMZN 3.20 21.08  566.21%
 08/05/94 4020 AOL 0.46 14.35  3,164.81%
 06/03/02 916 TREE 13.72 14.37  4.82%
 02/26/99 1145 EBAY 46.54 75.76  62.81%
 09/27/01 2260 MLNM 14.69 8.18  -44.29%
 SHORT 01/24/02 2500 SIRI 6.90 1.18  82.88%
 07/02/98 940 SBUX 13.98 19.80  41.74%
 12/16/98 1160 AMGN 21.44 50.87  137.29%
 SHORT 08/21/02 1000 GTRC 16.49 19.28  -16.99%
 04/24/02 290 SPY 110.16 89.25  -18.94%
      
  Trade Date # Shares Ticker Total Cost Current Value  Total Gain  
 09/09/97 1320 AMZN 4,220.20 27,825.60  23,605.40 
 08/05/94 4020 AOL 1,860.42 57,687.00  55,826.58 
 06/03/02 916 TREE 12,565.44 13,162.92  597.48 
 02/26/99 1145 EBAY 53,294.44 86,745.20  33,450.76 
 09/27/01 2260 MLNM 33,207.00 18,486.80  -14,720.20 
 SHORT 01/24/02 2500 SIRI 17,258.26 2,950.00  14,289.24 
 07/02/98 940 SBUX 13,138.62 18,612.00  5,473.38 
 12/16/98 1160 AMGN 24,875.50 59,009.20  34,133.70 
 SHORT 08/21/02 1000 GTRC 16,488.00 19,280.00  -2,808.00 
 04/24/02 290 SPY 31,945.00 25,882.50  -6,062.50 
Cash:573.54 
Total:319,482.26 


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Note
The Fool Portfolio was launched on August 5, 1994, with $50,000. It was renamed the Rule Breaker Portfolio in October 1998. The investing strategy began with the first investments of the Fool Port and has evolved with time and experience. In July 2001, the portfolio began adding $12,500 each quarter (We missed Jan. 2002, so we added $25,000 in April 2002). We skip a quarter if we have enough uninvested cash or cash available in stocks we would prefer to sell to make new investments. All transactions are shared and explained publicly before being made, and returns are compared in each week's column to the S&P 500 (including dividends where noted) and the Nasdaq composite. For a history of all transactions, please click here.