Stock Markets: US Markets Rally As War Rages

IN THE U.S., the long-awaited war rally is in full gear. Monday March 24, 5:32 AM (From The Asian Wall Street Journal) By Craig Karmin

The Dow Jones Industrial Average and the Standard & Poor's 500-stock index each are on an eight-session streak, the first time the Dow industrials have had such a run-up since 1998, and the S&P's first since 1997.

Since war in Iraq became imminent, the Dow industrials have risen 997.56 points, or 13%, and the Nasdaq Composite Index is up 12%, enough to wipe out earlier losses and send both benchmarks up so far this year. Last week's gain for the industrials was 8.4%, the biggest weekly advance in more than 20 years, going back to October 1982.

For most investors and traders, the template for the rally has been clear: By studying what happened to stocks the last time the U.S. took on Saddam Hussein in 1991, they can see a blueprint for what to expect this time around. So far, the comparisons have held up. Then, as now, the U.S. economy was facing a severe strain. Oil prices were high, and the financial system was working through a period of excess that ended with the bursting of a financial bubble and stock-market decline.

But many analysts and economists now are worried the analogy is being carried too far. Despite these apparent similarities, analysts warn that the U.S. economy and the stock market face a number of important challenges and uncertainties that were missing at the start of the previous Gulf War. They add those differences could be substantial enough to make comparisons to 1991 irrelevant. "Today's world is a far more unstable and much scarier place than it was in the aftermath of the Gulf War of 1991," says Stephen Roach, Morgan Stanley's chief global economist.

All of this has produced some fears the current U.S. stock-market rally may soon run it course, perhaps even faster than the rally sparked by the Gulf War. In 1991, the Dow industrials jumped 15% from Jan. 17, the day Operation Desert Storm was launched, to Feb. 28, when a cease-fire was declared. From there, the market was stuck in a trading range and ended the year down 10% from when the war ended.

This time, the markets have entered the war in a much weaker position. Despite the recent rally, the Dow industrials are down by nearly 20% during the past year and the Nasdaq composite is down about 25%. On Friday, stocks closed up sharply on news of an intensive air campaign in Baghdad and more rumors Mr. Hussein may have been killed or injured. In the New York Stock Exchange's most active session of the year, the Dow industrials rose 235.37 points, or 2.8%, to 8521.97, while the Nasdaq was up 1.4%,or 19.07 points, to 1421.84.

Yet many traders already worry this rally could soon fade. The military task was clearer in the previous war, when the goal was to expel invading Iraqi troops from Kuwait. Today, military planners are facing the much more complicated task of removing Mr. Hussein's regime from power and rebuilding the country.

Even once that happens, U.S. military challenges won't be over. The U.S. still faces a threat from global terrorism, and other potential international crises loom in North Korea and Iran.

Nor should investors count on an economic rebound in the U.S. once the guns fall silent. The economy in 1991 was in the middle of a recession and continued to struggle long after the first Gulf War was over. Although the economy is further along in the economic cycle than it was 12 years ago, a number of analysts warn that the recovery lag could take as long, and perhaps longer.

Many U.S. companies are trying to reduce debt, a strain that has discouraged new capital spending. State and local governments -- compelled by law in many states to balance their budgets -- have been raising taxes and cutting spending programs, providing another drag on the economy. American household debt is at record levels, and economists say the savings rate is inadequate. "All these factors will still be in play even if the war gets resolved in a favorable way," says Bill Dudley, chief U.S. economist for Goldman Sachs. "The economy looks weak and vulnerable to a shock."

The global economy is in worse shape today than a dozen years ago, meaning U.S. companies can't count on demand in Europe or Japan to compensate for a weaker domestic market. Since the U.S. is launching this fight without clear backing from the United Nations, Washington will be responsible for a bulk of the war costs.

"The only thing that looks better today than 12 years ago is that U.S. productivity numbers are up," says David Rosenberg, chief North American economist for Merrill Lynch.

From a valuation perspective, stocks were more attractive then. The current price-to-earnings ratio based on trailing 12-month earnings for the S&P 500-stock index is 31 -- about double that of 1991. Many economists say the stock-market excesses of the late 1990s were so spectacular it is going to take much longer to work through the excess than it did earlier in the decade. "This is a bigger bubble and with more pernicious effects," Mr. Rosenberg says.

While the U.S. Federal Reserve aggressively cut interest rates in 1991 and 1992 -- cutting the federal-funds rate 13 times, to 3% from 7% -- the situation today is much trickier. Now, that rate is at 1.25%, leaving the Fed little room to cut rates again if the war runs into trouble or if the economy weakens further. Mr. Rosenberg notes the 12 interest-rate cuts for the current easing cycle haven't done much to revive the U.S. economy because business overcapacity, rather than prohibitively high rates, is responsible for the downturn.

A U.S. slowdown would be less of a worry if markets in other countries looked healthy. But as in 1991, that isn't the case. "The world wasn't helping much then, and it isn't helping much now," says Carl Weinberg, chief economist for High Frequency Economics in Valhalla, New York. "Actually, it's bit worse today."

He notes Europe's economy was slumping in 1991, too. But European governments were taking much more aggressive steps to stimulate their economies through fiscal and monetary policy, so that Germany and the U.K. enjoyed healthy rebounds by 1993. Moreover, Japan's economy, now moribund, was strong, growing at a rate of 5% during the first quarter of 1991, compared with essentially no growth expected today.

U.S. corporations are in the process of repairing their balance sheets by reducing debt. Even as many companies cut costs to the bone, the profit downturn is lasting much longer, and has been much deeper, than in 1991 because of an inability to raise prices following a long period of corporate overinvestment.

Borrowing by U.S. consumers is another concern. Household debt as a percentage of gross domestic product stands at a record 83%, compared with 64% in 1991. Lower interest rates today take some of the sting out of the debt load, but many analysts say the burden is greater this time around.

At the same time, the U.S. has moved from a current-account surplus for the first quarter of 1991 to a widening current-account deficit that amounts to about 5% of GDP. This increases U.S. dependency on foreign capital, but it suggests the dollar will continue to weaken, which discourages foreign investors from buying U.S. stocks.

As in the fourth quarter of 1990, oil prices have been rising and approached $40 a barrel this month. In the weeks following Kuwait's liberation, prices sank to around $20 as supply concerns eased. This time, oil has fallen to below $27, and analysts say there could be further declines when the conflict in Iraq is over, though not to the same levels seen in 1991 because circumstances have changed. Venezuela has yet to return to full production following its recent oil-workers strike, and many other suppliers are near their capacity for pumping oil. Refining companies and other large oil consumers face low stock inventories. Higher energy costs, of course, hit the bottom line of U.S. companies.

Friday's Market Activity

Hopes that the war could be decisive and short helped drive strength in a number of stocks and sectors in the U.S. market. Airlines were the top performers Friday, with Southwest Airlines up $1.04, or 7.3%, to $15.28 even though analysts point out that the majority of stocks in the group remain significantly below levels of 18 months ago and a short war doesn't necessarily remove the threat of a bankruptcy-law filing for some of these companies.

Walt Disney gained 1.60, or 9.3%, to 18.74 as market participants speculated a short war would ease concerns about visiting tourist spots such as Disney's theme parks. Strategists also see a short timeline for a war benefiting advertising revenue.

Disney and nearly all of the 30 members of the Dow industrials finished in the black for the day; the only decliner was SBC Communications.

Intuit slid 12.17, or 24%, to 38.72 on the Nasdaq after the tax-software company said it expects pro forma earnings of $1.30 to $1.35 a share for the fiscal year ending July 31, down from its February estimate of $1.38 to $1.42 a share.

State Street fell 4.39, or 11%, to 34.11 after the financial custodial firm warned first-quarter operating results will come in between 45 cents to 47 cents a share, short of the 54-cent projection from Wall Street analysts surveyed by Thomson First Call.

Bank of New York, weighed down by State Street's warning, dropped 22 cents, or 1%, to 22.20. Bear Stearns and Prudential Securities lowered their earnings-per-share estimates for the company on concerns that the bank, which derives most of its income from fees tied to behind-the-scenes business like clearing stock trades, will suffer from continuing difficult business conditions.

-- Shaheen Pasha