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Sector scenarios for a postwar market
Take a look at where experts believe retail, gold, oil, defense and other sectors are headed in case the United States launches -- and quickly wins -- a war in Iraq.
By Michael Brush
No one knows how quickly a war with Iraq might finish. But that hasnt stopped bettors at the Web site TradeSports from taking a guess. They recently laid out 2-to-3 odds -- or a clearly better-than-even chance -- that the United States will quickly oust Saddam Hussein by the end of April.
Assuming theyre right, which sectors of the market will move the most, once a relatively quick end to the war is in sight?
Weve already gotten glimpses of the answers -- each time the hint of a peaceful settlement has surfaced. In these cases, stocks, especially the growth names, have shot up. Oil and gold have sunk.
But its not clear whether these trends would persist in a postwar market. Crucial questions remain unanswered because each time peace prospects have been raised, they have quickly vanished, as has the knee-jerk market dynamic.
There are other things weighing on the minds of investors besides Iraq, not the least of which is earnings, says Hugh Johnson, the market strategist at First Albany. Throw in doubts about capital spending and consumer strength, and its easy to see why it may not be wise to bank on a cut-and-dried market response to a quick war in Iraq.
To be sure, those bettors at TradeSports could have it all wrong, and a strike on Iraq could result in messy Baghdad street battles or a drawn-out regional struggle. These are scenarios that would render stocks much more unpredictable -- to say the least. Plus we havent even begun to talk about Korea. But assuming theres a quick finish to the war -- and thats what the odds say -- here are some of the sectors that will move the most, and how to consider playing them as an investor.
Retail: An early rally that fades
Expect retail stocks to rally sharply if it becomes clear that a war will be over quickly. Then, short them. Investors will be bidding up retail stocks on the false belief that consumers have kept their wallets shut merely due to worries about the possible war. Its not so.
Instead, underlying obstacles like unemployment fears, high debt levels and a mortgage-refinance slowdown will continue to limit consumer spending.
We havent found any evidence that consumers going out to buy a pair of shoes stop and think, Oh, there may be a war in the Middle East, I better not, says Kurt Barnard, president of Barnard's Retail Consulting Group, which surveys consumers to project spending patterns. It just doesnt work that way. Barnard doesnt expect solid retail sales growth to return to the United States until we see consistent monthly job gains of 100,000 or more.
Meanwhile, retailers will struggle throughout this year, he predicts, though there will be pockets of strength at discount stores and outlets selling items that new homeowners buy -- outlets such as Ethan Allen Interiors (ETH, news, msgs), Pier 1 Imports (PIR, news, msgs) and Rowe Cos. (ROW, news, msgs). Department stores like Federated Department (FD, news, msgs) and apparel retailers like AnnTaylor Stores (ANN, news, msgs) should continue to be among the weakest.
If you bet against retailers in a rally, dont do it too early because many of them are down so low that even a 10% to 15% rally will still leave them looking cheap. The sell-off in Michaels Stores (MIK, news, msgs) has value investors returning to the name. Even some retailers with excellent upward earnings estimate revisions look cheap, like Brookstone (BKST, news, msgs) and Mothers Work (MWRK, news, msgs).
Defense: A quick drop, then a long rise
Defense stocks are down so much since June, its hard to imagine they could sink much further. But two reasons may produce that result once its clear an Iraq war will conclude quickly. First, any remaining traders who thought these stocks would go up because of a drawn-out war will be selling. Second, a quick war might make people think theres little need for big increases in defense budgets because the military already looks strong, says Jon Kutler, president of Quarterdeck Investment Partners, an investment bank.
Since long-term defense spending trends are so positive, however, it makes sense for investors to buy into any dip in defense stocks, says Paul Nisbet of JSA Research, an independent research shop specializing in defense and aerospace.
Lawmakers in Washington, D.C., he points out, are gearing up for the biggest military shopping spree in almost 20 years. The binge will increase spending by 35% over the next five years. Much of the increase is for procurement, research and development -- which helps defense contractors -- as the military aims to build more smart weapons, a more mobile military and more ships.
Nisbet says he likes just about all defense stocks. But top names on his buy list include: Lockheed Martin (LMT, news, msgs), General Dynamics (GD, news, msgs), Northrop Grumman (NOC, news, msgs), Alliant Techsystems (ATK, news, msgs) and EDO Corp. (EDO, news, msgs). Nesbit thinks defense stocks will remain strong until investors get a clear and prolonged signal the economy is back on track; thats when investors will exchange defense stocks for growth-oriented names.
Travel and leisure: A solid advance that doesnt last
As soon as it became obvious that the United States had the upper hand in the 1991 Gulf War, this group took off. Gaming stocks leaped 43% within three months, and lodging stocks advanced 27%, compared to 18% gains for the S&P 500.
You can expect solid advances this time around, as well. Just dont expect them to last. The reason: Fears of terrorism and, possibly worries about Korea, will linger, keeping people close to home. I dont think the war is the factor holding these stocks back, said a financial adviser at a major Wall Street brokerage house. I think terrorism is the factor. Personally, my wife and I wont ever let a bridge or a tunnel separate us from our children because of the threat of terrorism.
That said, many of these stocks look temptingly cheap. Cruise-line company Carnival (CCL, news, msgs), for example, trades at just 13 times forward earnings estimates. In good times, it goes for around 20 times forward earnings. Whats more, some positive trends are in the air. Leisure stocks theoretically stand to benefit as Baby Boomers reach the stage of life when they have more money and more time for travel and fun.
Nevertheless, those worries about terrorism and cautious consumer spending have analysts cutting estimates on cruse-line stocks like Carnival and Royal Caribbean Cruises (RCL, news, msgs), as well has hotel companies like Starwood Resorts & Hotels Worldwide (HOT, news, msgs), Hilton Hotels (HLT, news, msgs), Host Marriott (HMT, news, msgs) and Four Seasons Hotels (FS, news, msgs). Leisure companies in general still suffer from too much capacity, and they face rising fuel and insurance costs, too.
Other leisure stocks to consider betting against in any postwar rally are Vail Resorts (MTN, news, msgs), Speedway Motorsports (TRK, news, msgs), Championship Auto Racing Teams (MPH, news, msgs), Expedia (EXPE, news, msgs) and Hotels.com (ROOM, news, msgs).
Cyclicals: A quick but unsustainable jolt
Companies in sectors like basic materials and chemicals will get a jolt at the close of a quick conflict, on the theory that the threat of war was holding back capital spending. According to this theory, a quick finish is all thats needed to get managers to open up capital spending, boost the economy and help companies like DuPont (DD, news, msgs), Dow Chemical (DOW, news, msgs), Praxair (PX, news, msgs) and Illinois Tool Works (ITW, news, msgs).
Not so, said Merrill Lynch senior economist Stan Shipley. He has looked at past recessions to determine the level of financial strength companies need before managers feel comfortable spending money again. And we arent there yet. A lot of people think that once the war is done, we are off the races on economic growth, said Shipley. But after you get a blip in capital spending, companies are going to look around and say That felt good, but we are still in trouble here so lets be restrained.
To be sure, a few financial measures show improvement. Inventory turnover, a measure of how efficiently companies use their stockpiles, has advanced. Unfortunately, crucial measures of financial comfort -- like profit margins and return on equity -- still lag. And debt levels are still too high. This holds back bond ratings, making it tougher to borrow. All told, balance sheet repair is in the sixth inning, said Shipley. So he doesnt expect a rebound in capital spending until 2004 or 2005.
Another major problem stands in the way. Theres still too much capacity, said State Street Bank economist Frederick Breimyer. Like Shipley, he doesnt expect a quick upturn in capital spending, even if a war with Iraq ends quickly.
Oil: A rapid dip, then a surprise surge
Unless lots of oil fields get wiped out in a war with Iraq, expect oil prices to plummet once it becomes clear a conflict will be over quickly. Tom Petrie of Petrie Parkman, an energy consulting company in Denver, Colo., thinks oil could decline to the low $20-per-barrel range, from recent levels of around $33.
If so, that will be a good time to go long on oil or energy stocks that sink with the price of oil, said Petrie. Unlike the last time around, oil prices will soon start to rise again after the initial fall, he says, thanks to a looming imbalance between global supply and demand.
This time around, many global oil fields produce less because they are more mature. Meanwhile, demand is higher because the world economy has gotten bigger. Then theres Venezuela, where worker strikes have badly disrupted supply. Its by no means clear that an end to political tensions in Venezuela will end work slow-downs and increase oil production there. The surprise will be that oil settles out at a higher level than most people think, said Petrie. It could easily move back to the upper $20 range, he said.
If energy stocks get hit as well, theyll be good buys, for the same reason. Petrie said its better to buy smaller energy companies like Murphy Oil (MUR, news, msgs) or Amerada Hess (AHC, news, msgs), instead of the majors like Exxon Mobil (XOM, news, msgs). The smaller firms have more flexibility to increase output as oil prices rise.
Rikard Ekstrand, an energy sector analyst with First Pacific Advisors, thinks rig and equipment makers Ensco International (ESV, news, msgs) and National-Oilwell (NOI, news, msgs) might make good buys if their shares retreat with the price of oil. The reason: Both have a lot of exposure to the North American natural gas market, where prices will probably remain high because of regional shortages.
Gold: A buying opportunity
Since gold currently serves as a haven for investors with war jitters, it will pull back if tensions with Iraq ease quickly. If so, buy it, because long-term trends are still favorable, said Howard Simons, a professor at the Illinois Institute of Technology. He thinks gold could drop as low $327 per ounce, a price that has served as a technical support level recently.
But then it would head back up for several reasons. Most importantly, said Simons, gold serves as a good hedge against expected inflation. Because short-term interest rates are lower than expected inflation, it pays for investors to borrow money to park in gold.
Another factor: Even if the United States wins quickly against Iraq, global tensions and the threat of terrorism arent going away. That will continue to make it harder for the U.S. economy to recover and add to downward pressure on the dollar. Both factors make international investors look for places other than the United States to put their money -- like gold.
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