Investors finally wising up to war
www.globeandmail.com By MICHAEL DEN TANDT
Tuesday, January 28, 2003 – Page B2
Here's a vexatious little puzzle: The markets have known for many months that U.S. President George W. Bush was intent on toppling Iraq's Saddam Hussein. Remember the "axis of evil" speech? Remember the Bush Doctrine of pre-emptive warfare?
And yet here we are, one year later, and investors appear to have just discovered the concept of political risk. The major indexes are getting hit, hard, by the prospect of war -- belying all the smug assertions of Wall Street strategists who've dismissed Iraq as quick blip on the way to a new bull market.
On Friday, the Dow Jones industrial average plunged 238 points, to its lowest level since last October. Yesterday, during the breathlessly anticipated report by Dr. Hans Blix, the top United Nations weapons inspector, the Dow hovered in the negative 50 range.
But within minutes of Dr. Blix's conclusion, after a short, hawkish press conference by the U.S. ambassador to the UN, the index was off 150. The industrials ended the day down 141.45 points, while the S&P/TSX composite index dropped 108.38.
Now, this has to be the most broadly telegraphed conflict in the history of the planet. The Persian Gulf is an armed camp. No one who reads newspapers or watches TV can be particularly surprised that weapons inspectors have gotten less-than-stellar co-operation from Iraq, or that Mr. Bush is now champing at the bit to get on with his invasion. So we can draw only one of two conclusions. Either investors had, until mid-January, been sticking their heads in the sand -- the Dow rose more than 6 per cent in the first two weeks of this year -- or some nagging worry about the specific nature of the coming war has risen to the fore in the past week or two. Or perhaps both are true.
Consider the benign scenario, based on a read of the market response to the first Persian Gulf war in 1990-91. Mr. Hussein's army invaded Kuwait in August of 1990. By November of that year, National Bank Financial's Vincent Lépine pointed out in a report last week, the Standard & Poor's 500-stock index had dropped 13 per cent.
Stocks then ground along a bottom until the onset of Operation Desert Storm, on Jan. 17, 1991. That day, the S&P rose nearly 4 per cent. By the end of the war on Feb. 28, the S&P had surged 12 per cent. Financials rose 19 per cent, information technology 18 per cent, and cyclicals 16 per cent. After that, barring a brief correction late in 1991, it was smooth sailing -- and onward to the greatest bull market ever.
There are parallels between the situation now and then. From mid-1990 until early 1991, for example, the greenback dropped about 10 per cent on a trade-weighted basis, similar to its weakening this time round. The U.S. dollar bottomed in the middle of the 1991 war, Mr. Lépine notes, and had recouped most of its losses by the fall of 1991. Lack of confidence in the U.S. dollar, primarily from overseas, has been a source of recent selling pressure on stocks.
Then, as now, the United States enjoyed an overwhelming military advantage. Indeed, in many respects, that advantage is far greater now, because 70 per cent of Iraq's conventional military was destroyed in 1991 and was never rebuilt, whereas U.S. smart-bomb capability has continued to shoot ahead. Most military analysts expect Iraqi forces will either surrender or be overwhelmed within days.
So why is the market rather suddenly taking this so hard?
For one thing, the United States this time round is politically isolated. Despite bluster to the contrary from senior Bush administration officials, no country -- not even Britain -- is unreservedly backing the U.S. push for war. The lack of a coalition removes a level of restraint.
Second, no one knows what carnage may ensue when U.S. forces move into Iraq's cities. Third, the government of Israel in 1990-91 was compliant and willing to remain sidelined, in the interest of keeping Arab allies on side. The current Israeli regime has sworn to strike back if attacked. Fourth, the oil supply outlook is far tighter now than it was in 1990. Venezuela remains crippled by a political crisis and OPEC has little spare production capacity.
Fifth -- and this is the kicker, for investors -- the S&P 500 was trading at about 15 times trailing-year earnings when the gulf war began. Today, the broad market trades at 26 times.