Waiting for the peace dividend
It goes without saying that the aftermath of the US-led war against Iraq is the dominant theme for the US markets and economy. Or does it? For some market participants, while seeing a post-war rally, the pre-war picture still holds and the same problems remain.
If unemployment is anything to go by, the economy is not in great shape. It lost 108,000 jobs in March, following a 357,000 fall in February. It was the fourth drop in employment in the past five months. And there are warning signs of weakness in the manufacturing and service sectors.
Lee Thomas, a portfolio manager at California-based asset manager PIMCO, says he was one of those who expected to see a “relief rally” in the stock market. Indeed, the rally had already started while the war was still going on. “That tone of optimism seems to have slopped over into other markets as well,” he says.
One cloud on the horizon was the increasingly anti-Syria comments being made by senior US officials. The expectation was, Thomas says, that another war was in the offing that would act as a “rolling drag” on the markets.
“Not only do we have the economy to confront but the rhetoric on Syria - it could be one more step in a rolling war.” He was surprised that the markets did not seem to be taking the Syria issue into consideration. “The US seems to be lining Syria up to be the next one,” he says.
And he notes that, despite the optimism about the relatively short duration of the war and the apparently limited knock-on effect throughout the Middle East, the fundamental issues of the US economy have not gone away overnight. “The economy still has the same problems it had before the war.”
He says markets were believing the “cheerleading” of Federal Reserve chairman Alan Greenspan. “Markets are buying into the Greenspan scenario.”
He says there’s a lack of capital spending – and that there could not be a “robust economic economy until capital spending picks up”.
“I am hard pressed to come up with a reason for businesses to invest in capital right now. I would have thought that consumption spending would fall first.” However, retail sales were holding up. “The US consumer continues to spend.”
Thomas says it’s difficult to make a case for investing in US stocks – he’s not buying as he assumes they are going to get cheaper. US stocks were not cheap on a price/earnings basis.
Thomas is not confident that President Bush’s tax cut plan would set off an economic recovery. “We need tax cuts just to keep the US economy from slowing further.”
From a monetary policy standpoint, Thomas says the market has stopped discounting further interest-rate cuts by the Federal Reserve. “The signal is that it is all over,” he says.
Ned Riley, chief investment strategist, global active equity at State Street Global Advisors, says: “To say that the Iraq war has created a discount in the market may be an understatement. I think the discount is around 20% plus.”
Riley was positive about the impact of the end of the war: “I still believe that resolution of the war will result in a fairly significant rally.” He says the “Iraq discount” started to develop almost 12 months ago. “My expectation is that at the end of the war better weather conditions and higher stock prices will lead to a better economy this year.”
Riley says that the high volatility of the markets during the war suited hedge funds had precluded “major participation” by some institutional investors and individuals. He says that lower expectations have made the market appear “as a rather dull asset in the future”.
Riley sees the economy and market being brought back to life by a revival in technology stocks. He notes that the Nasdaq has consistently outperformed the S&P 500 in recent months.
He disagreed with PIMCO’s Thomas in seeing a – modest – pickup in capital spending. Spending would accelerate “as better cash flows and more upbeat corporate expectations work their magic”, he says.
Nigel Richardson, senior investment strategist, at AXA Investment Managers, says the post-war emphasis will now shift back towards “longer-term fundamentals” and the question of whether the US could avoid a major economic downturn and whether the equity market has pulled out of three-year spell of “de-rating”.
Richardson says he believes fiscal and monetary policies would continue and that “modest growth will be sustained”. On the markets side, it was a simple question of yield. On this count, he says the US equity market “is now back to fair value”.
So it remains an open question whether there be a “peace dividend” for the US following on from the war in Iraq. Only time will tell.