Fears of Long Conflict May Set Back Markets
With American casualties and Iraqi opposition mounting over the weekend, the stock market could be susceptible to a pullback after its recent big advance, strategists said Sunday.
“Because we have seen more resistance from Iraq than a lot of people had been anticipating, we may see profit-taking sooner rather than later,” said Standard & Poor’s equity strategist Sam Stovall in New York.
On Friday, a 235-point rally pushed the Dow Jones industrial average’s gain over the last eight trading sessions to more than 13%. Other major U.S. stock indexes and many markets in Europe also have risen sharply. Meanwhile, gold and oil prices have tumbled to multi-month lows and Treasury bond yields have jumped by more than half of a percentage point.
At least part of the rally was due to investor relief that the uncertainty over whether there would be a war in Iraq had been resolved. But some of the enthusiasm was clearly a reaction to early reports of progress by the U.S.-led coalition forces, which fed hopes that war could be over quickly -- perhaps in as little as a week.
Those hopes may be fading somewhat. Over the weekend, President Bush and other U.S. officials told Americans not to expect an easy triumph and warned of fierce fighting ahead. Investors also were digesting reports of more coalition casualties and the capture of several U.S. soldiers by the Iraqis.
“In Friday’s trading, it was obvious that nobody wanted to be caught short going into the weekend, especially with all the rumors about Saddam Hussein possibly being injured or killed,” Stovall said, noting the high volume accompanying the Dow’s climb to 8,521.97.
“Now everyone can see that the war is not going to be a cakewalk, which is a sobering thought.”
Still, he said, “the general trend is going to be up unless we have some major developments that set back the American cause.”
Subodh Kumar, strategist at CIBC World Markets in New York, agreed.
“The key issue that’s been driving stocks higher while hurting bonds, oil and gold is that the impasse over what to do about Iraq is now over,” he said. “Clearly, however, it’s going to take the U.S. armed forces some time.”
Although war news will dominate the markets in coming days and weeks, the longer-term issue confronting investors is the health of the U.S. economy.
According to the bullish case, a quick and decisive victory over Baghdad would give American consumers and businesses a much-needed confidence boost.
“If you accept the fact that ‘Iraq-aphobia’ has been the thing holding back the U.S. economy for the last six months, you have to be optimistic about the hopes for expansion,” said Richard DeKaser, chief economist at National City Corp. in Cleveland.
If the war is settled without major battlefield setbacks or terrorist attacks against America, U.S. businesses would soon become more willing to hire workers, stock goods and make capital improvements, DeKaser said, and consumers would feel better about making purchases.
An emphatic victory in Iraq would make it easier for Bush to push an economic stimulus package through Congress without watering it down, investment strategists say. On Friday, the Senate rejected an attempt to scale back the administration’s tax-cut proposals, which are popular on Wall Street.
“A president with soaring approval ratings would have a much easier time getting things done,” said Thomas Girard, managing director at asset manager Robeco USA in New York.
Bush will focus on the economy in an effort to avoid the electoral fate of his father after the 1991 Gulf War, Girard said.
“The president can be hailed as a war hero, but he knows that if unemployment rises and the stock market languishes, people will be voting with their pocketbooks in 2004.”
Skeptics say that the positive reaction to initial successes in the current Iraq war doesn’t mean the 3-year-old bear market is over. Early enthusiasm for the military effort simply diverted investors’ attention from the troubled economy and other problems facing the market.
“The hype about how this war relief rally has put us on track for another bull market is just noise. The economy is weak and getting weaker,” said Kari Pinkernell, senior U.S. strategist at Merrill Lynch & Co. in New York. “There has been a knee-jerk reaction to buy stocks, but we don’t think this is the beginning of a longer-term, fundamentally based bull market.”
Recent data showing consumer confidence at a nine-year low and weekly jobless claims running high don’t offer encouragement, she said.
Even if the U.S. achieves a resounding victory over Iraq, other geopolitical risks could be looming, Pinkernell added, pointing to the possibility of terrorist attacks against Americans and growing fears about the defiant regime in North Korea.
With corporate profit-reporting season for the first quarter drawing near, earnings trackers say they see reason for guarded optimism, noting that Wall Street analysts’ profit estimates have risen in the last month.
Analysts surveyed by Thomson First Call expect first-quarter profits for companies in the Standard & Poor’s 500 index to rise 8.3% from a year earlier. On Feb. 18, analysts were expecting a 7.1% increase.
Chuck Hill, Thomson’s research director, said the numbers may be skewed by strength in the energy sector that is not sustainable, especially with oil prices backing off from their peak. What’s more, first-quarter profit warnings are running ahead of last year’s rate.
On a positive note, Hill said, “the big surprise has been technology.” Warnings in that sector have come at a modest clip and expectations for profit growth have held up relatively well.
Most companies don’t start reporting earnings until mid- or late April, but Hill said early signals may come next week from consumer electronics retailers Best Buy Co. and Circuit City Stores Inc. (April 1 and April 2, respectively) and Dow index component Alcoa Inc. (April 4) and the following week from General Electric Co. (April 11).
In the meantime, investors will continue to make decisions with one eye fixed on the news from the Middle East. And the market will remain vulnerable to “modest pullbacks as the war unfolds,” said CIBC’s Kumar.