Ready for the War Dividend?

Most pros are betting on a short but sharp relief rally

Wall Street is placing its bets that a war with Iraq will start soon -- and once it does, it will spell one thing for the stock market: r-e-l-i-e-f. That's right. Assuming that a war would be relatively brief, most investment pros say a "relief rally" will ensue, propelling the major indexes as much as 20%.

That's why many market pros are positioning themselves to ride the crest of a potentially big market tsunami. In fact, many say an Iraq rally may be the biggest -- and perhaps only -- substantial upswing for all of 2003. "Relief rallies are sharp and short," says Jack Caffrey, equity strategist at J.P. Morgan Private Bank. "The vast majority of gains often come in just a few days -- and they can be painful to miss." At least three broad themes seem to define the pros' strategy: shifting from bonds into undervalued blue chips, shorting oil and gold in anticipation of a rally, and investing in defense companies for the long term.

While some may find playing a war distasteful, market mavens point to a history of wartime rallies. Markets surged when the U.S. entered World War II and the Korean War, and rose as the U.S. deepened its role in Vietnam. They rallied when U.S. warplanes attacked Iraq in January, 1991, during the first Gulf War; by the time a cease-fire was declared in early March, the Standard & Poor's 500-stock index had leapt 18%.

So how are the pros shifting their portfolios today? For his part, Jeffrey N. Kleintop, chief investment strategist at PNC Advisors in Philadelphia, is eyeing what he calls triple-A stocks -- companies with AAA debt ratings and beaten-down valuations. Fitting the bill: American Insurance Group, Pfizer, and United Parcel Service. Says Kleintop: "As conflicts grow, the stock market falls because investors rush into safe havens like Treasury bonds. But once decisive military action takes place, the market rebounds and safe havens suffer."

That's precisely why Kleintop and others say investors should shift out of gold, cash, and Treasury bonds and into equities. Says William Knapp, portfolio manager at CitiSelect Funds, a division of Citigroup Private Bank: "Assuming there's a war, and it's fairly brief, there will be increased pressure on interest rates to rise." Indeed, in a relief rally, it's likely Treasury prices will sag, sending yields up. Of course, that may be a momentary blip. Many say the Federal Reserve probably won't begin raising interest rates, which are at a 40-year low, until yearend, giving investors more time to shift their allocation.

Some aggressive traders are also shorting stocks that have benefited in the prewar environment -- borrowing shares in hopes of buying them back at a lower price and pocketing the profit. Ken Wolff, president of, a momentum trading firm, is shorting both oil and gold stocks. Says Wolff: "If oil prices remain this high, it won't just cripple our economy but the global economy. So there's immense pressure on oil-producing countries to produce." He thinks gold will tumble as well. "People have been putting money into gold because they're scared, but that will pass."

Of course, there are always those Wall Street contrarians. Some believe oil prices will remain high long after the end of hostilities because supplies are lower now than they were during the first Gulf War. In a Mar. 4 report, Merrill Lynch & Co.'s chief U.S. strategist, Richard Bernstein, urged investors to boost their weighting of energy stocks. For his part, David Tice, manager of the Prudent Bear Fund, a mutual fund, believes gold prices will remain high, partly because investors will want a safe haven in what he assumes will be continuing global uncertainty.

Indeed, even pros who are currently focused on a potential short-term rally say there will be lingering effects of war. Wolff, for instance, is betting that defense contractors such as Lockheed Martin Corp. will do well over time. And J.P. Morgan's Caffrey likes small defense-technology companies such as L3 Communications Holdings Inc., which specializes in intelligence-gathering and secure-communications systems.

The pros know relief rallies usually fizzle in a few weeks, or even days. Beyond that, a tepid market, accompanied by high volatility, is almost certain to resume. That's because the economy continues to sputter along and earnings remain lackluster. So a rally of any kind in this market certainly spells relief.

By Marcia Vickers in New York

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