Wall Street Goes to War

By Daniel Kadlec

Like presidential approval ratings, stock prices tend to inflate when the U.S. engages in armed conflict. Look no further than the tireless bull market that we enjoy today. It began in 1991 when the U.S. drove Saddam Hussein and his Iraqi army out of Kuwait. The first allied air raids came on Jan. 17 of that year and sent the Dow Jones industrial average soaring 4.6% in a day. By mid-March the Dow had jumped 20%.

Yes, sir! The generals on Wall Street do love a war. There's nothing like the smell of smart bombs in the morning--as long as they're ours--to arouse feelings of invincibility. And what better frame of mind for dialing one's broker and cheerfully picking up another 100 shares of Boeing or Lockheed Martin? With Saddam the Sequel possibly only days away, I guess it's no shocker that the market has hit new highs for the first time in six months.

Be warned, though, that a Saddam II, if it does happen, would be nothing like the original--at least not in the stock market. When the Gulf War began, the U.S. was in the throes of a banking crisis and slipping into recession. Saddam was bent on hanging on to his oil-rich conquest. Stocks were down, and oil prices had briefly doubled to $40 per bbl. There was a lot to fight for. This time around, stocks are high and oil is low. The economy is on a historic roll. And Saddam isn't strong enough to upset any of that greatly; he is merely being defiant. Where is the market's upside?

Once a U.S.-led attack starts--if the situation should get that far--Wall Street is counting on a swift allied victory that would destroy Saddam's "germ factories" and perhaps even take out the tyrant himself. The generals on Wall Street are so certain of the outcome that in their minds they've already won the war and held the ticker-tape parade. And that's just the point. "There is a lot of room for disappointment," notes Tom McManus, a market strategist in Katonah, N.Y. "People have forgotten how easily things can go wrong." What if we don't quickly knock out Saddam's weapons of mass destruction? Other than a few diehard militarists, no one possesses the will to keep at it indefinitely.

Any measure of failure could upset the markets. For example, today's benign inflation and low interest rates are partly the result of cheap oil prices. And Wall Street expects that a defeated Iraq would be allowed to flood the world with oil to raise money to rebuild, which is one reason the price of crude has slumped since October from $23 to $16 per bbl. But would Iraq be treated with such kindness if an allied mission were unsuccessful? Doubtful. Such an outcome could reverse psychology in the oil market and send prices higher, stoking inflation and squeezing stocks and bonds.

Yes, success in the Persian Gulf would vindicate all those market patriots bidding up share prices. But because it is so widely expected, success would merely maintain the status quo--not inspire a whole new bull market. And for those who worry about a bungle, stocks of defense contractors, oil producers and oil services companies would be good hedges. Remember, those generals on Wall Street wear suits, not battle fatigues. They don't really know a thing about war.

Daniel Kadlec is TIME's Wall Street columnist. Reach him at [email protected]