Stocks Post War — Buyer Beware: Uncertainty Abounds
Is this really the beginning of a second Gulf War bull market, a time when the economy expanded and stocks rallied as never before? Maybe, but may not. Almost nobody disagrees that markets hate uncertainty more than anything else — even more than certain, bad news. In the first Gulf War, we had a certain outcome: we would drive Iraqi troops from Kuwait. Only time and cost (human and monetary) were at issue. We came to believe this was more video game than war. On CNN we watched a film of an auto racing across a bridge just nanoseconds ahead of a bomb tooth-picking that structure. We laughed when a general referred to the driver as the “luckiest man in Iraq.” We felt confident. We had allies. We felt morally justified.
There are larger pockets of skeptics this time. We have few allies going in. Some question our moral justification.
As far as markets go — even as victory unfolds — we face mounting issues yet to be discounted.
We are facing deficits as far as the eye can see, growing larger as we deal with the prospect of “maintaining the peace” in Iraq. Down the road, we need to deal with the possibility that democracy in Iraq is not in our best interests. With a large portion of the Iraqi people historically aligned with Iran, we’re likely to end up with an Iranian satellite nation if it came to a vote. Additionally, the majority has been at odds (‘mortal-enemies’) with every other subgroup in the country for centuries. Turkey lusts after the Northern Iraqi oil fields. There are conflicts between gun-and-bomb wielding factions stretching back as far as written history. Net, we may be confronted with genocide in place of any enlightened republic. And any elected Iraqi government is unlikely to support our policies in the Middle East especially with respect to Israel. And such political fallout seems unacceptable. And uncertain.
And what of deficits-as much as a couple of trillion over the next decade-in need of financing? To clear the market of a trillion dollars worth of anything requires lower prices. Lower prices — the economic enticement for inducing buyers to invest — in bond terms means higher yields. Higher yields — in an already weak economy — is not good. While Greenspan might opt to print money to pay down debt, that in and of itself has the same effect on rates. Increased supplies of greenbacks means the currency weakens. When the dollar trades lower, foreign capital flees our markets. This loss of demand has the same effect on bonds: yields climb. It is, quite simply, the supply/demand curve from Econ 101 in operation.
So, what are the costs of this peacekeeping in perpetuity at a time when we have managed to create deficits of $350 billion all by ourselves without the war? Let’s just say it’s big and uncertain.
Next, we have — rightly or wrongly — changed world politics and declared irrelevant the UN. Allies have become estranged. Threats of trade retaliation abound. Sure, a lot of this is chest-thumping rhetoric, but it’s still a source of — I hate to say — uncertainty.
With the handling of recent events, the standard for whom we negotiate with and whom we do not negotiate with seems to have changed. We seem disinterested in negotiating with those seeking weapons of mass destruction (Iraq) but will negotiate with those already possessing them (N. Korea). The incentive, it seems, is for countries to rapidly develop nukes and germs and caustic chemicals and then let everyone know that at any sign of aggression they will unleash the book of Revelations on the world.
Next, how’s all this going to play out on the tax cut front? Perhaps President Bush, with a new post-war mandate, will eventually force through much of his cuts after all. And if Bush wins his cuts, the benefits of that cut on the economy are still open to debate: is it simulative or does it merely increase the deficits? In any event, it is another in a long list of uncertainties this market will have to deal with.
Finally, what if the housing market hiccups? We’re already in enough economic trouble without that dark cloud threatening to deluge us. To make matters worse, we’ve got a Fed with few lower-interest-rate bullets left to fire. In 1991, we had Fed Funds at over 6 %. Today? Today that same rate is about 1.2 %. A world without Alan Greenspan’s magic wand of plummeting rates? Frightening. Fiscal policy is similarly handcuffed by cost over-runs and deficits. Ask Japan how it feels to try and get a moribund economy rolling with no engines on board.
Maybe the post-war rally will have long-term legs. My point is simply this: 2003 is NOT 1991 and this is a new, more uncertain game we play. And, as I’ve said ad nauseam, the market hates the ‘U’ word more than bad news. And that is a fact of life like no other.