TCS Daily

Taking Stock of War

By Jeremy Slater - April 3, 2003 12:00 AM

Observers of Europe's financial markets might have expected investors to be a bit preoccupied or even jittery as US and British forces launched their invasion of Iraq. But the start of the second Gulf war provided something of a spur to share prices and a boost to the markets.

At the outbreak of the conflict, on March 20, bourses in Europe registered climbs in prices of around 20% within a week, and similar rises were recorded on the other side of the Atlantic. It seemed we were witnessing a repeat of what happened at the beginning of the first Gulf war in January 1991. Investors responded to the removal of an important element of uncertainty that had been dogging confidence for much of the start of this year - namely, would there be a war and, if so, when?

However, that early surge in confidence petered out swiftly as predictions of "victory in five days" turned into something more realistic. With this realization traders remembered that they were dealing with companies that were under-performing and very unlikely to post results in the near future which may not justify their prices even at this level. Furthermore, recent economic figures on both sides of the Atlantic have shown the prospects for growth to be less than promising - at least in the short term.

However, oil prices have remained reasonably stable and affordable despite a gentle rise in cost over the past two months. OPEC has been able to maintain steady supplies - something it was unable to do in previous Middle East conflicts, from the Yom Kippur War through to the Iran-Iraq War. A hike in oil prices caused by those earlier crises had severe effects on the world economy and led to lengthy downturns after each of them.

But the longer the current war goes on the greater the likelihood that oil prices will head higher and that the world could face the type of economic downturn it suffered in the early 1980s and 1990s.

Investor confidence could also be hit by corporate earnings reports that are still struggling to inspire belief in the prospects for even the biggest European companies, such as in the much-benighted high-tech or telecoms sectors. These sorts of pressures could induce flight to investments other than shares, such as bonds or gold, favorites for investors in turbulent times.

This has already been happening to some extent in Europe's largest economy, Germany, where a new index, Nasdaq Deutschland, was launched just last month. Until the mid-1990s German investors had been known for their aversion to holding shares - preferring government bonds as a way of ensuring a return on investments. This meant that Germany had a much lower share-owning percentage of the population than many other European countries.

However, with the arrival of the high-tech boom opportunities to invest in high-growth high-tech shares this base started to grow swiftly, moving from under 10% to nearly 20% by the year 2000. Since then it has slipped somewhat as Germany's share-owning community's confidence has been shaken. Some fear that German investment behaviour has returned to its habits of old and that it will take a lot of encouragement to woo them back into the bourse.

One way to do this is by cutting the cost of share trading and making the process more transparent. Nasdaq Deutschland's model, which will offer cheap and efficient execution of trades, will undoubtedly help achieve this. But what will really bring confidence back is a series of healthy company profit reports and rising index prices over the medium to long-term.

Measures to spur economic growth, including, in Germany, much-needed labor market reforms, will also help. German Chancellor Gerhard Schröder has shown some willingness to consider these remedies and in recent days has entered into discussions with representatives of German business on how to grow the ailing economy. If these new talks come to anything they could help share prices rise, but don't hold your breath.

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