Sunday, 25 October 2015

The Day US Entered The Gulf War

It is the time of the year again as the world awaits US Federal Reserve (Fed)'s decision on Wed whether to raise interest rates. Although the majority view is that Fed would not raise interest rates at this meeting, the consensus was not so clear this time last month. I was busy wondering whether the economic implications of an interest rate rise would hold (i.e. stocks would fall) or the investor psychology of buying after a bad news would happen (i.e. stocks would rise). You can refer to A Jittery September for the thinking going on prior to the last Fed meeting. In the end, an event that happened 25 years ago settled the argument in favour of the latter.

It was 2 Aug 1990. Iraq had just invaded Kuwait, its oil-rich neighbour to the south. Oil prices promptly shot up from US$17 per barrel in Jul until it reached US$36 per barrel in Oct. Stocks fell correspondingly. The Straits Times Index (STI) fell from 1,557.80 points the day before the invasion and reached a low of 1,079.50 in mid Oct, for a loss of 31% in a short span of 2.5 months. Iraq had just emerged battle-hardened from an 8-year war with Iran and boasted an army of 1 million men with 5,000 tanks. It was the fourth largest army in the world. Throughout the second half of the year, people were worried about US going into a prolonged war with Iraq, with dire consequences for oil prices and the world economy. 

On 15 Jan 1991, US declared war on Iraq, codenamed as Operation Desert Storm. 2 days later, the war that people feared started with aerial assaults on Iraq. Yet, contrary to all expectations, stocks did not fall. Instead, they rose. STI rose 5.4% on the very day the war started. It was not an initial, knee-jerk reaction; stocks continued to rise until US ground troops liberated Kuwait and ended the war 6 weeks later on 28 Feb 1991. By the time the war ended, stocks had recovered almost to their initial levels prior to the war. The figure below shows the performance of STI during the period of the war.

STI Performance During Gulf War

If you had watched the 1992 Hong Kong drama "The Greed of Man" (“大时代”) starring Lau Ching Wan and Amy Kwok, this was the event that gave rise to the climax turnaround in fortune for the male protagonist.

Coming back to our time, on the one hand, my mind tells me about the economic implications of an interest rate rise, as described in Getting Ready for US Interest Rate Rises. On the other hand, my gut feel tells me that expectations for a fall in stock prices in the event of an interest rate rise had been heavily priced in and a counter-intuitive rally in stocks was possible. After recalling the above-mentioned event just before the Fed meeting in Sep, I decided to buy stocks in favour of an interest rate rise. As you know, the interest rate rise did not happen. Nevertheless, it resolved the last major consideration in deciding whether the "big bad bear" was coming. I thought I had another one month until the next Fed meeting in Oct to continue adding stocks slowly, but stocks went up unexpectedly in early Oct, thus ending my buying spree a little too early.

So, now, the world awaits Fed's decision again. Would the announcement of an interest rate rise (assuming it happens) set off a decline in regional currencies, gold, oil and stocks, or would it spark off a short-term rise in the very assets that are affected by interest rate rises, until the economic implications start to take effect in the medium-term? I am quietly believing in the latter. Having said the above, the recent stock rally has ended any further buying activity. Essentially, I do not buy stocks because I think they are rising; I buy stocks because I think they are undervalued, and at no risk of falling significantly. And in case I am wrong, there is still a warchest to rely on.

No comments:

Post a Comment