War Is Hell on Wall Street's Nerves

Talk of the U.S. invading Iraq is the kind of uncertainty investors hate. But if it comes, stocks will more likely dip than dive

By Eric Wahlgren

As President Bush struggles to persuade the rest of the world of the need to attack Iraq and oust Saddam Hussein, Britain seems to be the only U.S. ally so far prepared to sign on for the campaign. If the U.S. decides to basically go it alone in Iraq, Wall Street will have to do some persuading of its own: keeping investors who already have so much to be wary about from bailing out of stocks.

There's no question that invading Iraq would hurt U.S. equities in the short term. Soldiers coming home in body bags and potential repercussions in the Middle East would produce a dangerous mix for the stock market. Consumer confidence, which has remained remarkably buoyant so far this year, could plummet along with already shaky business confidence.

While few doubt that the U.S. would ultimately prevail in Iraq, no one knows how long such a war would take or how many lives it would cost. And that's precisely the kind of uncertainty that drives investors bonkers (see BW Online, 9/10/02, "Dealing with the Market's Great Unknowns"). Surprisingly, though, many Wall Street experts don't think the bottom of the market would drop out.


  The U.S. economy continues to plod ahead, suggesting that corporate profits -- a key determinant of stock prices -- will eventually improve. That would change if the conflict dragged on and military spending reached levels that began to sap the economy's strength. But for now, experts say even a protracted war in Iraq would shave no more than perhaps 10% or so off the major indexes.

In this environment, that's hardly Armageddon for investors. Of course, a lot would depend on what happens to oil prices. As they go up, it raises the cost of doing business, which cuts into profits, particularly in the industrial sector. Crude has already risen to about $29 a barrel, a "war premium" increase of about 25% so far in 2002.

Yet many experts say crude prices likely would stabilize after an initial spike on news of a military move against Saddam, partly because Iraq's share of the world oil supply is too small to cause a major disruption. The country furnishes about 1 million barrels of the world's consumption of about 77 million barrels a day, estimates John Kingston, global director of oil for Platt's, an energy-information services outfit in New York.


  Saudi Arabia could easily make up the gap if Iraqi oil was cut off, Kingston says. Moreover, over the years, the U.S. has been getting more oil from Russia and Venezuela to reduce its dependence on the Mideast.

One fear is that Saudi Arabian or Kuwaiti oil facilities could incur collateral damage. But "my prediction is that once there's some guarantee that these export facilities won't be attacked, you would see the war premium disappear pretty quickly," says Kingston, indicating a fairly low risk of oil prices shooting high enough to paralyze business.

While a war with Iraq would cause market suffering, stocks wouldn't feel the pain equally. Shares of integrated oil companies would benefit from higher crude prices, while exploration and drilling outfits would be lifted by the push to find and exploit new energy fields, Wall Street pros say. Also destined for a war boost would be aerospace and defense stocks, which have already gained 2.2% year-to-date, according to Standard & Poor's research. The same goes for gold stocks -- up 26% so far in 2002 -- as a foreign conflict would give investors yet another reason to shelter their cash.


  Meanwhile, shares of airlines, truckers, and "any other areas where incremental costs are based on fuel" would all be subject to selling, says Sam Stovall, chief sector strategist for S&P in New York. And travel-related stocks and consumer nondurables could be vulnerable to what Stovall terms the "CNN effect," when everyone is "glued to their TV sets and no one is spending money."

The last time the U.S. went to war with Iraq more than a decade ago, the stock market came out of the battle like the U.S. military -- pretty much unscathed. Sure, stocks dropped as it became clear the U.S. would send soldiers to drive Saddam from oil-rich Kuwait. By November, when the U.N. Security Council approved the use of military force to remove Iraq from Kuwait, the S&P 500 had fallen 14% since Iraq invaded in early August.

The market rebounded forcefully as the U.S. achieved victories in January and February, 1991. On Mar. 8, when the first U.S. soldiers began returning home, the S&P 500 closed 5% higher than it did on the day Iraq invaded Kuwait. A key reason for the gain was a "relief rally" on the news that Kuwait's vast oil reserves were more or less intact. "The market took off because it realized that the Kuwaiti oil fields weren't done irreparable harm and that Saddam Hussein's army would not put up much of a fight," Stovall says.


  This time around, the outlook is a little cloudier. "As long as there's uncertainty about how this turns out, stocks are going to go lower," says John Lonski, chief economist at Moody's Investor Services in New York. And that uncertainty is unsettling in an ugly market that's seeing the S&P 500 trade about 6% lower than the levels reached shortly after the September 11 terrorist attacks.

Stocks have been struggling for months, as investors flee to less risky investments after enduring accounting scandals and ongoing earnings disappointments. The benchmark S&P 500-stock index is down about 21% so far in 2002. But, at least for now, experts aren't predicting a free fall in stocks if the U.S. goes after Saddam -- even in such a volatile world.

Wahlgren covers financial markets for BusinessWeek Online in New York

Edited by Beth Belton

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