The looming war!
David Chapman
There are periodic points in history that become pivotal. In the past century dates that resonate as pivotal events are June 28, 1914 (assassination of Archduke Ferdinand WW1), October 17, 1917 (Bolshevik revolution), November 11, 1918 (Armistice WW1), October 29, 1929 (stock market crash), September 3, 1939 (Invasion of Poland WW2), December 7, 1941 (Pearl Harbour), August 6, 1945 (Hiroshima), August 13, 1961 (Berlin Wall), October 27, 1962 (Cuban missile crisis), October 19, 1987 (stock market crash), November 9, 1989 (Fall of the Berlin Wall), and September 11, 2001 (World Trade Center, Pentagon).
What is often more fascinating then the actual dates is what were the causes leading up to the pivotal dates. And as is more then often the case the real reasons are often hidden or not obvious to the public. So today we once again sit at a possible pivotal event. It may seem rather presumptuous to put the invasion of third world country run by a despotic dictator into the category of many of the above dates. But with a looming United Nations crisis the invasion of a third world country run by a despotic dictator without UN approval may very well turn out to be quite pivotal.
As we launch ourselves into a pivotal week at the United Nations both sides are lobbying intensely to either come up with the needed votes to pass the Security Council on the US/British resolution and deadline or come up with the needed votes to prevent its passage. Irrespective of whether it passes or not even if it does pass France appears poised to veto. And irrespective the split in the United Nations is extremely dangerous going forward as the institution will have suffered possibly a debilitating finishing split. For the worlds capital markets and investors this is a dammed if they do and dammed if they don't situation.
Everywhere we look the world economy is slowing. Germany, Japan, Europe, North America. An exception bucking the trend may be China but even it might succumb if everyone else is faltering. Everywhere stock markets are falling. Pessimism seems to be the order of the day. If extreme pessimism is supposed to make market bottoms then it can get even more pessimistic before a market bottom is seen. The Volatility Index (VIX) a measurement of fear and complacency in the market typically demonstrates complacency at levels under 20 and fear at levels over 50. At market bottoms in July 2002 and October 2002 the VIX peaked at over 55. But today it sits at a relatively neutral mid thirties. A long way from a market bottom.
One key area of rising prices and stability had been the housing market in the North America. But signs are beginning to show that it too is vulnerable. Word that Fannie Mae (FNM-NYSE) and Freddie Mac (FRE-NYSE) capital ratios are out of line sent a shiver through the market and could signal the death knell of the mortgage market. In the past year the mortgage and housing market has been a bright light along with consumer spending in keeping the US economy aloft. But with rising unemployment and unsustainable levels of mortgage debt and consumer debt in a falling market this may yet turn out to be a nightmare situation for numerous house owners. We have noted before that mortgage foreclosures have been at a record pace over the past year. Expect this to continue.
But the real key to the Middle East and Central Asia and key to the world economy going forward is oil. The region contains 80% of the world's oil reserves. The world's economy and most importantly the US economy is dependent upon a cheap steady source of energy. Control of the area is therefore paramount to ensure an uninterrupted steady flow. Rising energy prices are already beginning to bite and threaten to tumble the world into a recession. With a world awash in debt, a recession coupled with the potential for trade wars coming out of the disagreements at the UN over Iraq, we could easily turn a nagging recession into something worse.
In 1991 when the world last went to war in Iraq it was with the UN principle that nations do not have an open ended right to invade other countries. This principle was generally accepted and justified. Today the issue is different. In this case it is because Iraq had been ordered by the Security Council to rid itself of certain weapons. After 11 years there was no evidence that disarmament had yet occurred. The Security Council unanimously ordered weapons inspectors to go back into Iraq and make sure it was done. If consequences were to be paid by Iraq for non-compliance it would once again have to be debated and voted on by the Security Council.
Yet two things are taking place that make this very different from 1991. First almost daily the US and Britain have been bombing Iraqi installations in the no-fly zones. Numerous civilians have been killed. The UN Security Council has not at any time authorized these forays. Secondly and more important the US has stated that its goal is regime change and it was so stated long before September 11, 2001. There is nothing in the current UN mandate to authorize regime change. These differences distinguish today's looming war with Iraq from the Gulf War in 1991. This is a key reason behind the current rift at the UN although no one has specifically raised the issue of the daily bombings in the no-fly zones.
But there are also numerous other differences in comparing today to 1991. While numerous pundits have noted what happened to the markets in 1991 and as a result came to comparable conclusions that the same will occur again they need to be reminded that today's conditions are much different. First and foremost are the economic differences. In 1990 the US ran a small trade surplus. Today the trade deficit is $450 billion annually and climbing. Budget deficits were the order of the day with the Reagan/Bush Sr. administrations and similarly the current Bush Jr. administration has now record budget deficits. In both 1991 and today the US economy was in the throes of experiencing an economic slowdown.
In 1990 the stock market had been rising generally for 8 years from the 1982 lows with the 1987 stock market crash being the only significant interruption. The price earnings (P/E) ratio of the S&P 500 was around long-term normal valuations of 15-17. From 1926 to 1990 the P/E ratio ranged from roughly 7 to 22 with the last peak prior to the 1987 stock market crash. At the top of the stock market bubble P/E ratios hit 45 while today after the markets falling roughly 48% the P/E ratio is still around 28/30. While debt levels in the economy have roughly doubled during the time frame the US economy has also roughly doubled.
The consensus belief is that the once war starts it will trigger a huge stock market rally and that both gold and oil prices will fall precipitously as they did in 1991. But the markets are very different today then they were in 1991. In 1991 the stock market had been rising for 8 years with only the 1987 stock market crash and the 1990 invasion of Iraq interrupting that rise. Gold prices had been falling in waves since peaking in early 1980 with the last peak in gold prices in 1987 followed by a lower high in 1989. The spike in gold prices in 1990/1991 failed to take out the 1989 highs. Oil prices had also been falling since the mid-eighties and while they had recovered from their lows in 1986 the Iraq invasion of Kuwait caused a price spike or sharp bear market rally only. Oil prices resumed their downtrend after that not bottoming until 1998. The US Dollar had been in a steady rise since the Paris Accord of 1985 although it peaked in 1989 and had begun a downward decent.
Today the stock market peaked in 2000 and has been falling for three years. Gold bottomed in 1999 and has been in an uptrend since then. Oil prices also bottomed in 1998/1999 and have been in an uptrend ever since. The US Dollar peaked in 2001/2002 and has been in a downtrend since then. As well both gold stocks and oil stocks have been languishing in relation to the commodity price. Some say they have been weak because so many expect the price to fall once war breaks out. If the event has already been discounted then it is not likely to occur.
We leave you with charts of the Dow Jones Industrials, Gold and Oil showing the markets in 1990/1991 and today. While many are looking for similar market reactions in the current looming war as compared to what happened in 1991 the economic and market conditions and reasons for the war are very different. This could suggest that the consensus may be in for a surprise.
Note: Charts created using Omega TradeStation or SuperCharts. Chart data supplied by Dial Data.
12 March 2003
Charts and technical commentary by David Chapman of Union Securities Ltd.
69 Yonge Street, Suite 600, Toronto, Ontario, M5E 1K3 (416) 604-0533, (416) 604-0557 (fax) 1-888-298-7405 (toll free) email david@davidchapman.com
The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. Neither David Chapman nor Union Securities Ltd. take responsibility for errors or omissions which may be contained therein, nor accept responsibility for losses arising from any use or reliance on this report or its contents. Neither the information nor any opinion expressed constitutes a solicitation for the sale or purchase of securities. Union Securities Ltd. may act as a financial advisor and/or underwriter for certain of the corporations mentioned and may receive remuneration from them. David Chapman and Union Securities Ltd. and its respective officers or directors may acquire from time to time the securities mentioned herein as principal or agent. Union Securities Ltd. is an independent investment dealer and is a member of the Toronto Stock Exchange, the Canadian Venture Exchange, the Investment Dealers Association and the Canadian Investor Protection Fund.
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