WV Executive

With the sophisticated systems of news dissemination, society can count on learning about any form of crisis as promptly as they occur, which means that people can also react with equal promptness in a variety of ways. Witness the almost instantaneous reaction from Wall Street when a crisis is at hand. Indeed, the event sparking the reaction is not always a crisis; sometimes an election will spark a reaction. The most common occurrence has historically been that the market drops into a corrective stance, which likely feeds the mass assumption that investing one's money is a risky venture, at best, or a real gamble subject to the vagaries of politics and humankind. Such market reactions to the market can most likely be attributed to the survival instinct and fear of the unknown from investors who want to cut their losses and get out of the way if a market tic turns into a disaster.

Winds of War

Investment performance often seems to go hand-in-hand with the news: "Country X today sent troops into the area bordering . . ." followed closely by ". . .In the news from Wall Street today, the Dow plunged Y points when news of Country X's military move reached the trading floor."

I believe a look at market performance in response to world events throughout the years further feeds this assumption. Putnam Investments ran a chart of Standard & Poor's 500 Index percentage gain/loss after a series of history-making events. What makes this fascinating is that the rate of market response has not always fallen-and in some cases, inexplicably risen-in the expected proportion to the calamity of the event.

The Second Gulf War, or the invasion of Iraq, beginning in March 2003, showed a 1 percent increase in the S&P 500 Performance index during the beginning month of the war, according to figures cited by the Janus Capital Group in a June 2004 study. Three months after the start, the index had risen to 15.4 percent.

Presidential elections also can have an effect on the market cycle. An analysis posted February 2004 from the United States Department of Commerce of the period since 1930 showed that the summer months during election years were the strongest, with August the leader. In September of election years and all years since 1930, the market fell, only to recover in October. During election years, the market showed another drop before recovering nicely in December.

Although the outcome has not dramatically affected the market, the incumbency factor and party affiliation of the winner do normally cause a shift in the market returns for a time. A Janus Capital Study published in April of 2004 showed that since 1930, when a Democrat has unseated a Republican, the S&P 500 Index showed an average gain of 0.4 percent six months after the election and a gain of 0.74 percent 12 months after the election. When a Republican wins a second term, the market shows a 1.5 percent gain six months after the election but drops to 0.47 percent 12 months after the election.

The same Janus study looked at the Dow Industrials election year cycles from 1900 to 2000 and shows that the DJIA showed a year's median gain of 14.6 percent when a Republican incumbent won and 12.1 percent when a Democrat incumbent won, for an average gain of 13.3 percent. If the incumbent loses, however, no matter which party, the year's gain has been 4.2 percent.

Election years have also generally shown distinct seasonal patterns, no matter the outcome. The first half of the year performs slowly, only to accelerate during the second half. Market watchers warn, however, that past cycles are no guarantee of future performance.

Down, But Not Out For Long

While some market watchers are giving this advice in terms of warning would-be investors to not count on an upturn in the market to continue and produce enormous profits, their advice can swing in the opposite direction-to not despair when the market stumbles into a downturn in reaction to a significant news event. Investors and would-be investors might have to be reminded of this well into this new millennium. The Great Depression reminds us that downturns lasting more than a day or two cause investment anxieties among many Americans who grew up on stories of deprivation and hardship from their parents or grandparents.

A January 2003 research report from Capital Research and Management Company suggests that the stock market historically has spent more time being bullish than bearish. Even some catastrophic market events, which had no definable "outside" world event triggers, recovered within a few years. The 1929 crash was a three-year bear market, albeit a costly one, that has left lasting scars but also led to regulations to prevent a recurrence. The October 19, 1987 record one-day plunge of 500 points in the DJIA, which led to exchange floor reforms, regained its value by September 1989.

An additional look at the historic events cited earlier further confirms the market's recovery abilities. Putnam followed up its study to see how the market fared one month, one year, five years and 10 years after the last reaction date for each event. Their results found (all statistics reflect a gain, unless otherwise stated, see end of article).

The Second Gulf War, or the invasion of Iraq, showed an S&P 500 Performance Index increase of 15.4 percent three months after the March start and an increase of 18.5 percent over that figure six months later. One year later, the increase was at 35.1 percent, according to figures cited by the Janus Capital Group.

Given that the market is sensitive to world events, and it does tend to recover after at least one year's time, the question arises whether a would-be investor should "bulletproof" his or her portfolio just for these occasions. Some investment advisors are recommending this action, and some investors are listening. It is not a good idea in my view. Fear should never drive investment decisions.

Defensive Portfolios

Suggestions for defensive "war" portfolios began to appear in the aftermath of September 11, the military strikes in Afghanistan, the Israeli-Palestinian conflict and the days leading up to the war in Iraq. Investors generally were advised to load up on defense industry stocks, gold and United States government securities. Some recommended oil stocks on the premise that a Middle East war would dramatically push up the price of oil. In an economy seemingly unfettered by the rationing of World War II, others promoted the stocks of companies producing products that consumers will buy regardless of the circumstances: food, tobacco, medicine, etc.

According to experienced financial advisors, it is the same principle as having a very defensive portfolio whose asset allocation mix is always braced for a market downturn. Yes, markets periodically falter, as they have in recent years, and a conservative portfolio might serve one well at that point. The problem is that people rarely can forecast a market downturn, and in the meantime, people can miss out on the growth, which, over the long haul, I feel has more than overcome the downturns.

If the idea of a defensive portfolio sounds familiar, it should. As recently as the fall of 1999, when alarmists warned of the impending Y2K disaster, some panicked investors converted all their investments to cash, often with significant tax consequences and missed market returns. Unlike the Y2K scare, terrorism is real. However, Americans have been hit by war before, and in most cases, the economy and stock market have weathered them well. Review the figures for Pearl Harbor and the first Gulf War.

Although most investors will maintain their current portfolios, some continue to panic and switch from long-held asset allocations to these "war" portfolios. Other investors have hunkered down with a lot of cash, though other factors, such as the economy, the Enron aftermath and the back-and-forth of the stock market have contributed to their nervousness.

In my opinion, the smarter move is to stick with a portfolio that is well diversified and that reflects one's own long-range financial goals, risk tolerance and personal circumstances. I believe investors should be investing only for the long-term, such as for retirement and college, and not let potential catastrophes-whose dimensions are unknown and which could affect portfolios in unpredictable ways-dictate a portfolio's makeup.

Most planners will argue that investors following a disaster-driven portfolio are taking an extremely conservative approach, and as a consequence, they are more likely to fail to reach their financial goals. They can suffer more from inferior long-term returns than because of the shorter market declines due to a disaster. Besides, these planners say, if a national catastrophe that truly crippled the nation were to strike (widespread, devastating terrorist attacks or even a nuclear strike, for example), even the most carefully crafted "war" portfolio would unlikely be of much value in the aftermath.

For those investors who still feel defensive about their portfolio, some financial advisors recommend tips that can help but not hobble the overall portfolio too much. One suggestion is to designate perhaps 10 percent of the portfolio to a defensive position, such as United States Treasuries, precious metals, cash and real estate. Another is to buy certificates of deposit from financial institutions located in different geographic areas.

Ultimately the best defense is likely a well-diversified portfolio that over time will potentially perform satisfactorily regardless of the circumstances. A portfolio that holds foreign stocks and foreign bonds, for example, which many financial advisors recommend under normal circumstances, could help blunt the effects of damage to the United States. However, global investing does involve risks not typically associated with United States investing, including currency fluctuations, political instability, uncertain economic conditions and different accounting standards.

In conclusion, continue to follow the news, including reports on the ups and downs of the stock market. Learn to recognize them for what they most likely are-temporary responses to a constantly changing world drama-and keep looking ahead.

Wachovia Securities did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author and are not necessarily those of Wachovia Securities or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy.

The S&P 500, (a registered trademark of McGraw-Hill Companies), and The Dow Jones Industrial Average, (a registered trademark of Dow Jones and Company, Inc.), are unmanaged indices of common stock. Unmanaged indices are for illustrative purposes only. An investor cannot invest directly in an index.

Information has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. Past performance does not guarantee future results. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns.

Investment products and services offered through Wachovia Securities Financial Network, LLC member NASD/SIPC. 0904-05041

Putnam's examples outline the following facts regarding investment performance:

• The Fall of France (May 9, 1940 through June 22, 1940): loss of 16.9 percent;
• Pearl Harbor (December 6, 1941 through December 10, 1941): loss of 7.5 percent;
• Korean War (June 23, 1950 through July 13, 1950): loss of 12.2 percent;
• Eisenhower Heart Attack (September 23, 1955 through September 26, 1955): loss of 6.6 percent;
• Cuban Missile Crisis (August 23, 1962 through October 23, 1962): loss of 9.9 percent;
• JFK Assassination (November 21, 1963 through November 22, 1963): loss of 2.8 percent;
• United States Bombs Cambodia (April 29, 1970 through May 26, 1970): loss of 15 percent;
• Nixon Resigns (August 9, 1974 through August 29, 1974): loss of 13.4 percent;
• Falkland Island War (April 1, 1982 through May 7, 1982): gain of 5.5 percent;
• United States Invades Grenada (October 24, 1983 through November 7, 1983): loss of 2.1 percent;
• United States Bombs Libya (April 15, 1986 through April 21, 1986): gain of 3 percent;
• Financial Panic of 1987 (October 2, 1987 through October 19, 1987): loss of 31.5 percent;
• Invasion of Panama (December 15, 1989 through December 20, 1989): loss of 2.1 percent;
• Gulf War Ultimatum (December 24, 1990 through January 16, 1991): loss of 4 percent;
• World Trade Center Bombing (February 26, 1993 through March 1, 1993): loss of 0.3 percent;
• Oklahoma City Bombing (April 19, 1995 through April 26, 1995): gain of 1.6 percent; and
• September 11 Terrorist Attacks (September 10, 2001 through Sept. 21, 2001): loss of 11.6 percent.

How the Market Fared after Historical Events:

• The Fall of France: one month, 0.7 percent gain; one year, 5 percent gain; five years, 15.7 percent gain; 10 years, 13.2 percent gain;
• Pearl Harbor: one month, 2.1 percent; one year, 15.8 percent; five years, 18 percent; 10 years, 17.1 percent;
• Korean War: one month, 10.2 percent; one year, 42.2 percent; five years, 27.7 percent; 10 years, 18.5 percent;
• Eisenhower Heart Attack: one month, 0.5 percent loss; one year, 11.9 percent gain; five years, 8.4 percent; 10 years, 11.5 percent;
• Cuban Missile Crisis: one month, 15.5 percent; one year, 41.1 percent; five years, 15.8 percent; 10 years, 11.1 percent;
• JFK Assassination: one month, 7 percent; one year, 27.8 percent; five years, 12.4 percent; 10 years, 7 percent;
• United States Bombs Cambodia: one month, 6.4 percent; one year, 49 percent; five years, 9.3 percent; 10 years, 9.3 percent;
• Nixon Resigns: one month, 6.8 percent loss; one year, 30.2 percent gain; five years, 14.6 percent; 10 years, 14.6 percent;
• Falkland Island War: one month, 7.3 percent loss; one year, 46.6 percent gain; five years, 25.1 percent; 10 years, 17.7 percent;
• United States Invades Grenada: one month, 2.8 percent; one year, 9.4 percent; five years, 15.9 percent; 10 years, 15 percent;
• United States Bombs Libya: one month, 3.5 percent loss; one year, 23.8 percent gain; five years, 13.2 percent; 10 years, 13.7 percent;
• Financial Panic of 1987: one month, 7.1 percent; one year, 27.7 percent; five years, 17 percent; 10 years, 18.9 percent;
• Invasion of Panama: one month, 0.8 percent loss; one year, 0.2 percent loss; five years, 9.2 percent gain; 10 years, 18.2 percent gain;
• Gulf War Ultimatum: one month, 17.2 percent; one year, 36.6 percent; five years, 17.3 percent; 10 years, 18 percent;
• World Trade Center Bombing: one month, 2.1 percent; one year, 8 percent; five years, 21.8 percent; 10 years, 8.7 percent;
• Oklahoma City Bombing: one month, 2.5 percent; one year, 30.6 percent; five years, 25.5 percent;
• September 11 Terrorist Attacks: one month, 11.3 percent; one year, 11.1 percent loss.