March 17, 2003
End Game
By using ‘Weapons of Mass Destruction’ as a pretext for war, instead of focusing on Saddam’s horrible human rights record and/or the case for a regime change, the U.S. has been unable to amass International support for an attack on Iraq. Accordingly, a ‘coalition of the willing’ is preparing to strike Iraq this week: the ‘unwilling’ being most Brits, France, Germany, Russia, China, etc.
“Unable to locate Iraq's U.S./British-supplied weapons, unable to link Iraq to Osama bin Laden, Bush and Blair shifted gears. They now claim Iraq's suffering people must be "liberated."” Margolis
That the U.S. may attack Iraq without UN support – probably also without the UN vote promised by President Bush – could be problematic. Quite frankly, if Saddam is capable of inflicting serious damage (i.e. blowing up oil fields, attacking his neighbors, killing innocent Iraqis, etc), there is the strong likelihood that ‘anti-Americanism’ tensions could escalate. However, a horrifyingly ironic speculation is that if Saddam unleashes chemical or biological agents – the very weapons he claims he doesn’t have – this could serve to legitimize the U.S. led war against Iraq.
Military strategists believe the war against Iraq will be quick, and most economists/ Federal Reserve Board members do not believe that the war will have a lasting impact on the financial markets. In sum, there can be little doubt that the U.S. led coalition will win the fight, yet the question of how many black eyes the U.S. will receive during the battle remains.
Fed Prepares for End Game Volatility
“Greenspan & Co. are putting in place contingency plans to restore calm to the markets and to shelter the world economy from a financial meltdown. The three-pronged strategy: Flood the economy with money to keep financial markets functioning, cut interest rates to spur growth, and intervene in the currency market to avoid a diving dollar.” Business Week
After reading the above Business Week article the investor is left with a simple question: what else is new? To be sure, the Fed has already been cutting rates with abandon, and the Fed is always prepared to take actions to avoid a diving dollar. As for the argument that the Fed will ‘flood the economy with money to keep the financial markets functioning’, this is probably the most ridiculously obvious statement anyone could make. Note to BW authors: the Fed was formed in 1913 for the purpose of printing and efficiently distributing money.
What the Fed is really readying to do is combat a crash in stock prices. The concept of the Fed purchasing stocks directly is nothing new. Rather, it was first suggested by Federal Reserve Board Governor Robert Heller soon after the 1987 crash:
“Instead of flooding the economy with liquidity, and thereby increasing the chance of inflation, the Fed could support the stock market directly”. Heller.
I know I am probably beginning to sound like a broken record when it comes to the supposed actions of the PPT. Nevertheless, plunge protecting stocks is not merely about the Fed buying -- it is also about everyone else buying because they think the Fed is buying and/or will buy. If, and when the U.S. stock markets break below their former lows, there may be the opportunity to buy both undervalued companies and/or ‘tradable’ stocks. Essentially the Fed’s job is to keep stocks ‘tradable’.
FOMC Meeting
The Fed is unlikely to cut interest rates this week unless the stock markets collapse, and the FOMC statement will likely blame Iraq for economic weakness. It is uncertain whether or not the Fed will change its bias from being neutral to leaning towards cutting rates in the future.
“My base case is that they'll hold steady and put a brave face on the numbers”
John Ryding, chief economist at Bear Stearns
This Week
With the Iraq End Game set to arrive, there is little reason to believe that any of the economic reports will influence trade. That said, there some reports to keep an eye on this week, along with some earnings releases (from banks).
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Following last weeks plunge in consumer confidence, March is already shaping up to be worse than a terrifically ugly February. This week the Philadelphia Fed will offer a first read on manufacturing activity for March (last week it was reported that Industrial Production gained slightly in February).
Is Iraq A Market Positive?
Beyond the war premium in oil, which may only be a few dollars a barrel given Venezuelan supply problems and the near record low in U.S. inventories, there is reason to doubt the popular conclusion that Iraq uncertainty is responsible for recent U.S. economic weakness. For certain, the U.S. consumer was already showing signs of retrenching in late 2002, or before Iraq fears really began to escalate. Moreover, the stock markets previously crashed in July 2002 and in October for reasons not related to Iraq.
For those of you who like twisted logic – Iraq has helped the stock markets avoid crashing in recent weeks! Nearly all the economic numbers are screaming recession, corporate earnings estimates have been slashed, and tech spending estimates (Merrill survey) have sharply declined. Iraq is the scapegoat: it allows investors to ignore bad economic news.
However…
Although Iraq has helped the markets ignore bad news, there is no reason to believe that if Iraq becomes page two news tomorrow that the markets will not initially cheer this development (and rally even if the economic reports remain ugly for a period of time). In short, if the Iraq war goes well and/or there is no domestic terrorism issues following an attack, the financial markets will follow the Gulf War trend: stocks will rally, gold will drop, oil will drop, etc.
“There is a reason why financial markets run to extremes more often than coin flips – and more often than the “hundred-year storm” that Long-Term’s partners would later cite as the culprit behind their disaster. A key condition of random events is that each new flip is independent of the previous one. The coin doesn’t remember that it landed on tails three times in a row; the odds on the fourth flip are still fifty-fifty.
But markets have memories.” Lowenstein. When Genius Failed.
I am not optimistic that the ‘attack Iraq rally’ will have staying power. In fact, whenever the rally arrives it is likely to be short and sweet (perhaps until 1Q03 earnings begin rolling around). Nevertheless, the markets do have memories; if Iraq uncertainty is squashed the odds that the stock market rallies are considerably higher than 50%.
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