March 24, 2003
Bear Market “could be longer and more difficult" than some predict
The Dow has gained 13.3% over the last 8 sessions. MarketHistory.com calculates this to be the ‘second-best eight-day streak ever’ (the ‘best’ eight-day streak being a 17.2% rally in September 1896). Not surprisingly, strength in stocks has meant weakness in other asset classes, including Treasurys (bonds), gold, and oil. And while many on Wall Street were predicting that the equity ‘war rally’ would continue after Friday’s close, recent developments in Iraq look to pressure stocks early this week.
Early Optimism
Heading into the weekend the war against Iraq looked like it would be over in a matter of days. To be sure, on Friday it was widely reported that US led forces had ‘secured’ the strategically important port town of Umm Qasr, that oil fields were under control, and that Saddam was rumored to be either dead or injured. Furthermore, on Saturday CNN was flashing the headline ‘Basra captured’, and Iraqi Colonel Khaled al-Hashemi, commander of the 51st Mechanized Division, was said to have surrendered. Suffice it to say, these and other newsflashes helped the global stock markets cap off a spectacular week, and helped turn Wall Street managers into military analysts (quotes from Friday March 21):
“Mark me surprised if we haven't got some sort of a declaration of victory within 10 days.”
Robert Morris, who oversees $48 billion in stocks and bonds at Lord, Abbett & Co.
“The world is looking for the headline that Saddam Hussein is dead and his regime is done. If he's removed, this war could be wrapped up in less than a week”
John Person, an energy analyst at Infinity Brokerage in Chicago
“Signs are they [allied troops] are meeting no resistance.”
Jim Paulsen, who oversees $110 billion as chief investment officer for Wells Capital Management in Minneapolis.
Sunday Bloody Sunday
"We have come here to liberate them and they want to fight us?" US Marine
Little could Wall Street have known that what they were watching on television was a disinformation campaign; a campaign intended to ‘shock’ the Iraqi military into surrendering. To be sure, by Sunday a nameless British officer stated “The important thing is not to take Basra but to get through it and get to the north. We won't get into fighting in downtown Basra”. Basra was no longer ‘captured’ but merely ‘surrounded’. Moreover, Colonel Khaled, previously thought to have surrendered, said he was ready to fight, and surrender totals dropped dramatically (the new American stance was that Iraqis had simply dropped their weapons and went home). Then resistance surfaced in previously secured places; oil fields were infested with Iraqi snipers, and Umm Qasr was home to ‘small pockets of resistance’. Suffice it to say, the word ‘secure’ was no longer being used.
As if the news of guerilla type forces embedded within urban areas in Southern Iraq was not bad enough, a series of negative and shocking developments followed on Sunday. As MSNBC reported, a U.S. soldier ‘probably gone mad’ tossed grenades into his officer’s tents, a US Patriot missile knocked down a British plane, Iraqi forces captured and killed US soldiers that took a wrong turn outside the town of Nasiriyah, and a ‘stiff’ battle ensued by a Euphrates River crossing. In short, Mr. Paulsen’s comment of ‘no resistance’ on Friday was all but forgotten by Sunday. In what many US soldiers now call the ‘Baghdad 500’, it has been learned that allied forces encountered no resistance because they had not been ‘securing’ cities. Mr. Morris is likely to be surprised when victory is not declared within 10-days.
“So while US forces raced towards Baghdad, they did not appear to have taken any major cities.” Reuters
Uncertainty over Duration of War
Given that resistance in Southern and Central Iraq has been tougher than expected - that the surrender totals are in the low thousands not the tens of thousands – there is reason to believe that initial expectations of a quick war have vanished (for the moment). A Financial Times article leads with ‘Ominous signs for coalition in battle for Umm Qasr’ and the Washington Post headlines ‘Basra Defenders Burrow Into Residential Areas’. The basic question in both of these articles being that if allied forces are encountering stiff resistance in Southern Iraq, what awaits them in Baghdad?
The events that unfolded on Sunday March 23 – Iraqi’s fighting not surrendering - suggest that Iraq will not be easily conquered by ‘shock and awe’. Rather, Iraq will likely be conquered in a street to street, building to building battle. Such battles – possibly taking on a ‘surround and starve’ strategy - are likely to take weeks or months, not days; such battles are likely to carry with them allied casualties along with heavy civilian causalities.
Regime Destruction is Inevitable
As for Saddam -- whose tactical choices appear limited to defending Baghdad or mounting one final, horrible WMD attack -- a NY Times insider states ‘Top Baath Party leaders tell my Kurdish friends that Saddam's strategy is to use guerrilla tactics to give France and Russia two weeks to negotiate a truce.’ After failing to target Saddam in Gulf I, and with Bush’s political future on the line, it doesn’t seem possible that a truce can be negotiated. Nevertheless, stranger things have happened.
As this weekend has proven, the perception of war can change quickly. One day all of Southern Iraq is secure, Saddam is dead, unknown ‘terrorists’ have lobbed grenades into tents, and the next day bloody urban conflicts loom in Southern Iraq, Saddam may be alive, and a traitor is captured. The stock markets rallied strongly last week as the Iraq war seemed to progressing with no setbacks. The opposite could be true early this week. The International community is mostly opposed to the Iraq War. If the chemical manufacturing site(s) discovered by allied forces on Sunday contained WMD world opinion of Saddam will change…perceptions can change quickly.
Market Mayhem
Of the 102 industries (tracked by SIC codes) only one industry is down over the last 5-sessions: Gold. Of the 102 industries only 6 declined on Friday.
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While the above industries (bolded) read like a who’s who of ‘defensive stocks’, the top performing industries over the last week highlight exactly how optimistic some investors are. Airlines, Hotels, and Advertising – three industries expected to be hit the hardest by the Iraqi war - were all in the top-10 performers.
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Clearly what the post-attack reaction in stock markets suggests is that market participants are unwinding their war bets and looking past Saddam. Remember, perceptions can change quickly.
Conclusions
There remains the possibility that Iraq will be defeated swiftly, that no terrorism issues will surface, and that the US economy will rebound as consumer’s temporarily rejoice. Nevertheless, these ‘possibilities’ hardly outweigh realities: Bush is going to have a difficult (impossible?) time providing more fiscal stimulus as war costs add to deficit figures, and the Fed has done essentially all they can do.
Accordingly, the main reason why the bear market could be longer and more difficult than many expect has little to do with Iraq or geopolitical issues. Rather, the important issue to focus on is the fact that the exploding stock market bubble has already forced the Fed and US government to use what powers they have to boost/stabilize the economy. As the Fed scrambles to boost the money supply and the government tries to give investors tax free dividends, the Iraqi war is labeled a drag on the US economy…the Iraqi war could be over tomorrow – all of us hope that it is – yet the Stimulus Brothers would still be faced with the same problem: how do you quickly change investor and consumer perceptions of the world when you can not absolve their debts and/or guarantee that their losses will soon turn into profits?
In sum, US consumers and investors are becoming increasingly risk adverse. This is what the economic statistics have been telling us since late last year and what the stock markets/bond markets have been telling us for the last 3-years. This process – from spending and investing in anything to saving and being a more cautious investor – has taken time to develop. Those that believe this ‘process’ will revert back to the mania days, like those who previously predicted Iraq would be conquered in days, are likely to be proven wrong in the future. Needless to say, referring to those analysts who believe stock market valuations are not important because Iraq will soon fall, Wall Street’s disinformation campaign never ceases to amaze.
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