Market Watch : How Will Land War Affect Stocks’ Course?

The stock market shocked almost everyone when it soared--instead of fell--when the Persian Gulf War began in January. Now, with the ground war finally under way and stocks at or near all-time highs, where does Wall Street go next? The outlook:

Q: The ground war seems to be going extremely well so far. Is that likely to bring buyers pouring into stocks today?

A: Many investors certainly will be cheered. But remember that many of the market’s bulls have been buying stocks like crazy since the air war began Jan. 17. That’s what has driven the Dow Jones industrial average to 2,889.36 as of Friday from 2,508 in mid-January, up 15%. The big question is what the investors still on the sidelines will do.

Q: Were there any early signals Sunday of investors’ intentions?

A: Stock markets in Japan, Australia and Taiwan rose in early trading today (Sunday evening PST), but the gains weren’t dramatic.

In the United States, discount brokerages and major mutual fund companies that offer 24-hour phone service said there was no wild surge of calls Sunday. At the Vanguard Group mutual funds company in Valley Forge, Pa., a spokesman said there was a “small increase” in calls for information about funds and “a little more expression of interest in energy-stock funds.” But beyond that the scene was very normal.

Q: But why shouldn’t investors buy now? If this war is over in a hurry, isn’t that bullish?

A: No doubt a quick victory would be a big boost to consumer and business confidence, and that should help the economy, now mired in a painful recession. But both groups, the bulls who have bought stocks recently and the fence-sitters who haven’t, have reason to pause here. They’re both wondering the same thing: whether the market was already anticipating a fast victory in the rally that started in mid-January.

Q: We’re to believe that the market was that prescient?

A: That’s often how things work, however uncanny it may seem; the market often does a great job of seeing the future. When the actual event occurs, it’s no surprise.

Q: But why would the market stop here? Doesn’t the rally have a head of steam going?

A: It did--before last week. The Dow and most broader indexes had shot almost straight up since Jan. 17. But last week the rally halted. The Dow lost 45 points.

Q: That’s not exactly a collapse.

A: No, but many analysts say the market was ready to pull back a bit even without the start of the ground war. “You just can’t keep going up powerfully every day,” notes Glenn Cutler, editor of Market Mania newsletter in Pacifica, Calif.

“We’re at a point of over-extension,” Cutler says. The fact that many stocks now are at or near historic highs naturally gives people pause, he notes. If you wanted to buy in January, you weren’t faced with the risk of buying at an all-time high because the Dow was off 16% from its record of 2,999.75 set last July. But now, “every time we shoot up near 3,000 you’re going to get some sellers,” Cutler says.

Q: So if we assume the market could pause, even if the war goes well, what’s the worst case?

A: Cutler believes that stocks could fall about 5%, but no more. If the Dow were to give up 5% from its 1991 high of 2,934, reached Feb. 15, it would drop 150 points to 2,784. That would be enough to attract new buyers, Cutler says.

Some bears believe that stocks are headed straight down from here. But historically rallies as powerful as the recent one don’t end this quickly. They generally “consolidate” for a bit then restart as more nonbelievers join the bulls.

Q: What if the allies suffer a major setback in the ground war?

A: That could turn more investors bearish, no question. But the market has a number of very important cushions right now.

Q: What kind of cushions?

A: Most people believe that the allies will prevail, even if it takes longer than we’d like. That’s an underlying mental plus for stocks.

Also, if the markets became badly spooked, it’s highly likely that the Federal Reserve would move quickly to push interest rates lower again. The Fed has been cutting rates since last fall, as it has become clear that the economy is in recession. That has been a big help to the stock market.

Finally, there simply are many investors who are eager to buy on any significant pullback, because they’ve missed the boat so far.

Q: Well, at least once the war ends for good, the market will lose its biggest headache, right?

A: Yes. But the war also has been a convenient diversion for Wall Street. When it ends, investors will have to contend with an even greater unknown, notes Frederick Ruopp, head of money manager Chelsea Management in Los Angeles: whether the recession really is going to end by midyear. That’s what most investors are betting. But if we go through another month or so without any signs of economic recovery, that will damper hopes of a quick recovery in corporate profits. And remember: In the long run, profits are what determine stock prices.

Q: So it’s back to basics?

A: Exactly. As the war winds down, Wall Street probably will become obsessed with economic indicators, much the same as it did at various times in the 1980s. If we get early signs of recovery, the market may become unstoppable this spring. But if the economy continues to sink--look out below.

THE DOW: AT A TURNING POINT

The stock market has surged almost straight up since the Gulf War began Jan. 17. But last week, the rally finally ran out of gas, and many experts see prices coming down in the short term, even if the ground war is a fast success.