Don't panic. In war, share prices can go up as well as down

Fears over Iraq continue to depress the world's stock markets but history suggests that the outlook might not be so bleak as it seems

The war in Iraq may not yet have begun but the casualties are already mounting in Britain's shareholding democracy. Even before a shot has been fired, more than £60bn has been knocked off the value of the UK's biggest companies in the past fortnight.

But the good news for those who have lost out is that, in times of war and other geopolitical events that shake the financial world, the pain tends to wear off quite quickly. Investors with the patience to wait usually make back what they have lost.

A classic example was the Second World War, when share prices dropped as the storm gathered and in the early stages of the conflict but then began to appreciate even as the war was still raging. By 1945 they were back where they had started.

The trouble is that this time shares were in ragged retreat long before the latest threat of war. They had peaked at the turn of the century. Since then it has been all downhill, with valuations, as measured by the blue-chip FTSE 100 share index, more than halved.

In 1999 the so-called TMT (technology, media and telecom) boom was largely responsible for the FTSE 100 reaching its all-time high of 6,950.6 points, with the shares of any company containing the merest hint of a hi-tech involvement soaring. Then suddenly the stars of what had become known as the new economy lost their appeal. They had been driven too high, too quickly.

For a time, old economy shares – such as brewers and retailers – attempted to take up the running. But with the US economy looking increasingly fragile and talk of a worldwide recession, the stock market was in the doldrums. It is now in its fourth year of decline – the worst losing run since the Great Depression.

So the prospect of another war with Iraq comes at a time when the stock market is already sliding. I would suggest that perhaps Iraq has so far cost the FTSE 100 about 1,800 points; the rest of the slump from the millennium peak would have occurred anyway.

The last major, long-running retreat was in the mid-1970s, when oil prices and interest rates soared, power was rationed, property prices collapsed, a banking crisis developed and Britain had to contend with a three-day working week. It was the time of the Yom Kippur War, when Egypt and Syria attacked Israel. Shares fell for more than two years before a dramatic rally, according to popular myth led by the Prudential insurance giant.

The Suez confrontation in the 1950s had a relatively minor impact on share prices. They ended the year marginally below the level reigning before Egyptseized control of the Suez Canal.

In 1982, the Falklands War, too, had little influence. There were, of course, bouts of anxiety. But the end of hostilities was the signal for one of the best bull runs ever witnessed.

At first the confrontation caused a sharp downturn in share prices. However, the lost ground was regained within days. Shares then went to a new all-time high before a run of Argentinian successes created concern. Then victory, and shares, were back on the march again.

Shares had more than doubled from the Falklands days before Black Monday devastated prices. In what still stands as the speediest correction ever witnessed, share prices crashed, with the FTSE 100 slumping in a few weeks from 2,300 points to about 1,500, destroying fortunes as billions of pounds were wiped off share values.

Military considerations played no part in the crash – but nature did. It could be argued that shares were heading for a sharp fall, as the stock market grew increasingly concerned about the US economy. Suddenly, transatlantic warning signals grew more compelling. But it was the horrific 1987 storm, devastating much of southern England, which did a lot of the damage. It prompted the closure of the stock market on a Friday because so few market men were able to overcome the resultant travel chaos. Consequently, an opportunity to absorb the first impact of the worsening US fall-out was lost. So when the stock market reopened on the following Monday many investors, fearing the worst, rushed to sell shares that many already regarded as overvalued. With the stock market in such a fragile state, panic quickly fed on panic.

Even so, the 1987 crash now looks like little more than a blip on the FTSE 100's progress chart. And so does the last military confrontation – the 1991 Gulf War. True, shares retreated and there were acute worries about the outcome. But it was a short, sharp conflict and investors were not slow to recover their enthusiasm.

From then on, just a few interruptions marked the FTSE's progress. The ousting of Margaret Thatcher was one. Then Britain's inglorious departure from the ERM signalled yet another heady run, with the demise of Barings merchant bank and even the near collapse of the Russian economy failing to make any significant impression on what appeared to be an unstoppable run.

Even the 1997 election of a Labour government, an event which would have been certain to create deep despair at one time, failed to blunt the FTSE's progress. However before the war clouds appeared, the Labour bull market had given way to the (Gordon) Brown bear market. Now the nation's insurances, pensions and savings are under increasing threat as share valuations are eroded.

It is the long run-up to war with Iraq, giving investors too much time to fret, that has caused much of the damage. The best stock market scenario is a short, sharp and, of course, victorious war followed by a long, comfortable rally.

Many big investors, however, fret that any war with Iraq, just like the Second World War, will not produce the quick victory many then predicted. And, with economic worries also unsettling the stock market, it is easy to focus on the clouds of deep gloom hanging over shares.

But the stock market has a habit of shrugging off disasters – and it will do so this time round, although it may be a long time before it recaptures its old, heady exuberance.