Will Your Portfolio Become a Prisoner of War

Will Your Portfolio Become a Prisoner of War - Will Your...

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Will Your Portfolio Become a Prisoner of War? Lessons From History and Psychology Brett N. Steenbarger, Ph.D. www.brettsteenbarger.com This is a draft of an article that appeared on the MSN Money website ( www.moneycentral.com ) in February, 2003. “War is good for the economy”. “The market is retreating on war fears.” Investors often entertain contradictory notions regarding the impact of war upon their portfolios. Many look to the last Gulf War for guidance, expecting that market prices will decline before the first shots are fired, only to rebound thereafter. If this is the way markets typically respond to war, the current prewar environment may present opportunities. Conversely, prewar bullishness may merely reflect the “availability heuristic” described by Amos Tversky and Daniel Kahnemann, where we base our conclusions on only the most available, recent wartime data. How do markets respond to international hostilities, and what might this mean for current investors? In this article, I will touch upon psychological research on stress to suggest that the relationship between stock market performance and wartime is a function of uncertainty. As a proxy for the economic value of entire countries, markets discount unfavorable or doubtful war outcomes and accord premiums to nations that succeed in conflict. Indeed, a careful examination of the trajectory of equity prices during recent
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important implications for your portfolio. Stress and Uncertainty A large body of research finds that there is a curvilinear relationship between the probability of negative outcomes and emotional stress. When the probability of receiving an electric shock, for example, is close to zero, people feel safe and do not display such stress responses as elevated heart rate, galvanic skin response (sweating), and stress- related hormones. At the other extreme, when the probability of getting the shock is close to 100%, individuals typically respond with coping measures and control their stress response. When the prospect of being shocked is near 50%, however, there is considerable uncertainty. Not knowing how or when to cope, the uncertain individual displays highly elevated stress reactions. Indeed, uncertainty is so intolerable that even experimental animals will choose a predictable powerful shock over an uncertain, but lesser jolt. Extending this research to markets leads to what might be called a Fortunes of War Hypothesis : As a country becomes successful in its war efforts, investors will view the future with greater certainty and optimism and reward that country’s markets with increasing prices. When the outcomes of war look unfavorable or are unknown, investors will shy away from the markets, resulting in decreasing prices. Let’s take a historical look at markets and wars and see how well this hypothesis
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Will Your Portfolio Become a Prisoner of War - Will Your...

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