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Posted 2/24/2003
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3 reasons to expect a war rally
I see the financial markets rallying in the near future, but dont expect it to last. The big problems that bedeviled the economy before the war will still be with us when it's over.
By Bill Fleckenstein
Financial pundits have always gravitated toward simplistic reasoning. It's no different now as, against the backdrop of a looming battle with Iraq, they paint a prospective war rally in simplistic terms. As an antidote, in this week's Contrarian Chronicles, we'll look at the complex mosaic surrounding a potential war rally, and see how rationalization may shape its length and breadth.
Rationalization, of course, has served our Fed chairman well. The damage from Alan Greenspans lingering bubble is simply explained away as angst over a looming battle.
Buying-time shares
Everyone pretty much knows that war uncertainty has raised the angst level in the financial markets. And that has certainly raised the level of chatter in the mainstream financial press. On that score, I would caution people against reading too much into what it claims are reasons for the market's day-to-day activity. For instance, I saw many reports attribute the Valentines Day rally on Feb. 14 to the notion that a war in the Persian Gulf might be delayed. This is not a conclusion that I came up with, and of course, no one knows for sure. The waiting is still going on.
Perhaps the market was just getting ready to rally, and it did. Nevertheless, the financial press seems to have pronounced a potential postponement of war as its geopolitical flavor of the moment.
This is a contradictory variation on the dichotomy about people wanting to buy the outbreak of war but fearing the events that lead up to it. This variation sees both war and the postponement of war as bullish. In real life, obviously, things can't be that way. Though it is not possible to determine the twists and turns that will take place in the next couple of weeks, it seems very clear to me that Iraq is going to be disarmed forcefully, and I expect that we will adhere to whatever timetable has already been planned. My admitted guess is that war with Iraq will start sooner rather than later.
Meanwhile, as the holding pattern continues, I thought it would be worthwhile to discuss my three reasons for expecting some kind of rally on the back of war. Here they are:
Investors think they see clarity. Markets, be they commodity or financial, generally breathe a sigh of relief when uncertainty is resolved. When the war breaks out, this will trigger a knee-jerk response that could last anywhere from 15 seconds to two weeks. Thats what happened in 1991 when the United States and its allies attacked Iraqs army to get it out of Kuwait.
Investors think maybe the outcome will be a better world. Its possible that the war would result in the world being a better place. This is a controversial idea, but it happens to be my view. I say controversial because one could argue that the world will be a worse place. (Thats the French-German-Russian position.) There is plenty of room for argument on both sides. My goal here is not to convince people of my view (I know that many disagree with me), but just to make the point. If the war goes well and produces the belief that the world is a better place, that will add some fury to the rally. If it goes the other way, that will undercut the rally. In any case, I don't really want to get into politics, but since politics and markets can flop together, sometimes this can't be avoided.
Fading battle fatigue -- were tired of weakness. Third, we could expect a rally on the back of war, just because people now have an excuse to rationalize all the weakness we have been seeing. I say that because denial is still an important ingredient in today's investment landscape. Just think back to what people believed after Sept. 11. All the earlier problems that had been pressuring the economy and the stock market were laid at the doorstep of the terrorist attacks. But the Sept. 11 attacks were not, in fact, the root cause of the stock market sinking or the economy's weakness as of Sept. 10, 2001.
This is just one example of the predisposition to blame market and economic weakness on anything but the bubble that came before.
So, while Iraq has added a level of geopolitical angst, that does not account for the trouble with the economy and the stock market. My view, as I have pointed out frequently, is that post-bubble trauma continues to plague us. The bubble's chief fomenter, Easy Al , has argued that Iraq angst has been the culprit for what's holding back our economy. Al (aka Greenspan) would no doubt be taken aback by some comments in the Feb. 14 edition of The Liscio Report: "The implication is that once the war is behind us -- and perhaps as soon as it starts -- a healthy recovery will set in. According to a Gallup/UBS Employee Outlook poll released this morning, this analysis is wrong. By an 86% to 8% margin, employees at private for-profit companies say it's the state of the economy, not the possibility of war, that's hurting their firms now." (The emphasis is mine.) Further, "Just 18% of respondents say the possibility of war is hurting business and 9% say it's actually improving things. But 71% say it's having no effect." It's important to remember that these problems will be with us long after Saddam isn't.
In any case, it is this third and last provocation for a rally (just another packaged excuse for the proverbial "second-half story") that I intend to fade (short) with a vengeance. But depending on what happens to the other two, I will essentially fade any subsequent rationalizations there as well.
No news is good news, apparently
Aside from the war, I would just note that judging by market history, we have entered the period when the likelihood of a rally is at its highest. I am speaking of the "no-news' period that falls in the middle of earnings season. Things are not getting better, but this lull in the news never stopped anyone from spinning fantasies that a bright tomorrow lies just around the corner.
This is a rather complex, three-pronged picture. Given that complexity, I don't agree with many in the bear camp who believe that the overwhelming expectation of a rally will prevent it from happening. (If stock prices were cheap, I would be wildly bullish right now.) I do, however, agree that the more people who expect a rally, the less dynamic and the shorter it will be. So my advice is buyers beware. It isn't knowable yet how this will all play out.
Humvees and hummus
The war rallys length and magnitude will be dictated by how events unfold (and how well discounted they already are), with respect to the three points I discussed. Whether the rally is measured in minutes and fractions of percentage points, or weeks and handfuls of percentage points, is also not knowable at this moment in time. In any case, I hope that framework will provide some food for thought over the next few weeks as people chew on where and when they should sell into the rally that I anticipate.
I'll have more to say about selling the rally after it develops. Meanwhile, I think it's important for people to have some idea of what to expect before the rally really gets under way and the rationalizations start coming fast and furious. Of course, I must add this caveat: I could be dead wrong about all of this.
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