Iraq war launches stock market rally
24 March 2003
The war in Iraq has finally started and, as many expected, stock markets around the world have rallied. Operation Iraqi Freedom, the code name for the US-led invasion of Iraq, appears to have freed stock markets from the restraints that had been holding them down for the past few months.
Stocks in the US and around the world made solid gains in the week ended 21 March 2003. The Dow Jones Industrial Average closed the week at 8,521.97. It climbed 8.4 percent for the week, its biggest weekly gain since October 1982. It is now up 13.3 percent from its low point of the year at 7,524.06 on March 11, having rallied for eight consecutive days, and is ahead 2.2 percent year-to-date. The broader Standard & Poor's 500 Index is up 7.5 percent for the week, closing at 895.79 on 21 March.
Other markets also showed good gains. The Nikkei 225 closed at 8195.05 on 20 March, up 2.4 percent for the week. It missed Friday's rally as the Tokyo market was closed. In London, the FTSE 100 closed at 3861.1 on 21 March for a 7.2 percent weekly gain, while in Singapore, the Straits Times Index closed at 1326.15, up 6.0 percent for the week.
Moving in the opposite direction are gold, oil and US Treasuries. Gold prices fell to US$332 per ounce on 21 March, well off a high of over US$381 per ounce in early February. Oil prices fell 24 percent last week to below US$27, the lowest level in three months and the biggest weekly decline since January 1991, when the first war against Iraq started. US 10-year Treasury notes had their biggest weekly drop since December 2001, with yields up 40 basis points. Yields on 2-year notes rose 25 basis points last week. 10-year Treasury yields have surged 54 basis points and 2-year yields have climbed 45 basis points since 10 March.
The question on many people's minds now is: Is all these overdone?
The fact is that many people are not convinced that the stock market rally is justified. "The perception may continue for a few weeks or months that with Iraq out of the way, everything is going to come up roses and the economy and stock market will improve," says Jean-Marie Eveillard, a value manager at First Eagle Funds. "But I think that's bull. Longer term, things will reverse back to a negative trend."
Credit Suisse First Boston, in a report last week entitled "Now that it is on, what next?" opined: "Much as we openly acknowledge that we are surprised by the magnitude of the rally even before military conflict began, we are unable to join in the rally as its cheerleaders or camp followers.
"Indeed we believe that the war – given the manner of its launch and the ambiguous clarity of purpose behind it – has the potential to add further uncertainties to the underlying weak economic picture. Therefore, once relief and celebration at the launch of the war is exhausted, the risk premium on financial assets has to rise."
Credit Suisse First Boston pointed out that recent US economic data carries "the message of substantial economic weakness", citing an 11 percent drop in housing starts in February, a slump in retail sales, a slide in the purchasing managers' index, rising unemployment, falling consumer confidence and a drop-off in the manufacturing indices.
In an earlier report on 17 March, Merrill Lynch suggested much the same thing. "We think it is incorrect to assume that a regime change in Iraq will solve the world's problems, and we do not believe that the equity market has adequately factored in the potential for long-term risk," wrote Merrill Lynch's senior US strategist Richard Bernstein.
Equity valuations are also unfavourable to a sustained rally. Bernstein pointed out that the "S&P 500 trailing P/E based on reported earnings remains extraordinarily high". After the recent rally, the S&P 500 is trading at about 30 times earnings – about twice its historical average – while according to David Briggs of Federated Investors, the Nasdaq 100 is trading at 32 times forward earnings.
Added to these concerns is an element of complacency on the expected progress of the war. In a Bloomberg report on 22 March, Robert Morris, who oversees US$48 billion in stocks and bonds at Lord, Abbett & Co., reportedly said, "Mark me surprised if we haven't got some sort of a declaration of victory within 10 days." And Steven Price presumptuously wrote in OptionInvestor.com: "With a quick war now a foregone conclusion, what will fuel the rally further?"
Therefore, stock markets are vulnerable to disappointment on two counts: The war may not go as well as expected, and even if it did, it may not make much difference to the world economy or global stock markets.
Investors would do well to go into the coming week with these points in mind.
Disclaimer: The commentaries posted here represent the opinions of the author at the time of posting and should not be taken as investment advice. Readers who wish to take any investment action based on information obtained from this site should seek appropriate advice from a qualified financial adviser.