Alan Reynolds

Does the stock market hate both war and peace? Nearly everyone had been saying stocks were depressed by war uncertainties that would vanish with victory, bringing a huge victory rally. Why didn't that happen?

Sure, it will take several months to get Iraq oil back on the market. Meanwhile, the U.S. government has unwisely decided not to fill that void with strategic reserves. Sure, there are still big uncertainties about the costs and dangers of occupation. But two of the biggest uncertainties have, in fact, been resolved -- namely, the duration and damage of war itself and the risk that Iraq's oil fields might be seriously damaged.

A new study available at nber.org, "What Do Financial Markets Think of War in Iraq?" concludes that "war lowers the value of U.S. equities by around 15 percent." Professors Leigh, Wolfers and Zitzewiz even offer lukewarm tips: "War is bad for consumer discretionary industries, airlines, finance and information technology." It seems to follow that winning the war should have raised U.S. stocks by 15 percent, but that hasn't happened. There was more involved than war jitters.

This is the third year in a row when pundits tried to blame weak stocks on touchy investor psychology. Last summer, the stock market was said to be depressed because previous corporate scandals had caused a loss of investor confidence. After President Bush got behind the Sarbanes-Oxley accounting bill, however, the Dow fell 400 points in two days. Stocks have yet to regain the level that existed before the government kindly offered to restore our confidence in federal regulation.

In 2001, the favorite theory was that the market was down because a bubble had burst. Stocks were down because they had been up. This is a remarkably unsophisticated theory of financial markets, which may explain its popularity at the International Monetary Fund. The IMF estimated that a $10 rise in oil prices would cut U.S. economic growth by 0.6 percent. Yet now that oil prices have fallen about $10, the IMF reduced its forecast of U.S. economic growth. Those who always insist on being gloomy about the United States naturally prefer psychological to logical explanations.


Alan Reynolds

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