How Will Wall Street Define Victory?


Like the rest of the country, ever since September 11, Wall Street has pined for a sense of safety and stability. True, the stock indexes have rebounded to around where they closed the day before the terrorist attacks, in part buoyed by Fed rate cuts and policymakers' assertive plans to stimulate the hard-hit economy. But many hoped the beginning of military action against the terrorists responsible for the mass murders would provide just the jolt of steely resolve necessary to pump up jittery consumers, the stock market, and the overall economy.

Alas, it was not to be -- and the continuing uncertainty will linger for some time to come (see BW Online, 10/9/01, "Finding Your Bearings in the Turmoil"). Although the government proclaimed the initial air attacks on Taliban targets in Afghanistan successful, investors were unmoved. The markets closed mixed on Oct. 8, with the Dow down 51.83, to 9069.94, while Nasdaq climbed by just 0.65 points, and the S&P Index fell 8.94 points. On Jan. 17, 1991, the day that Operation Desert Storm was launched, the Dow rose 34 points (Nasdaq was still in its over-the-counter infancy), going on to post an 11.5% gain through Feb. 27, 1991, the day a cease-fire was declared.

Operation Desert Storm, however, was an overwhelming show of military force that seemed destined for success from the moment the fighting began. But a victory in the war on terrorism will be much more ethereal for Wall Street. If anything, the markets may ultimately define success, not so much on whether U.S. forces hunt down Osama bin Laden but by the absence of future terrorism on American turf, analysts say. "It's hard to define what the end of this is. You're not going to know what you've achieved until you have several years of no terrorist activity," says Ed McKelvey, senior economist at Goldman Sachs.

"UNCONVENTIONAL WAR." That's not to say that a successful military campaign won't play a role in market psychology in the days ahead, says Kim Wallace, Lehman Brothers' chief political analyst. But the ultimate measure will likely be a common perception that the U.S. and its allies have made sure terrorists can't strike again. And that's a much longer-term proposition.

"Let's presume we look up in six months and nothing horrible has been inflicted. That's a good sign. Either [the terrorists'] capabilities were destroyed, or the deterrent message was so effective that they have recoiled for a while -- a long while," Wallace says. The markets -- in the U.S. and elsewhere -- are most likely to regain their footing in a prolonged period free of terrorist attacks. "When we've downed the capabilities of terrorists to indiscriminately inflict pain," Wallace adds, "the risk premium on global markets starts to shrink."

The logistics of finding bin Laden in rugged terrain, combined with the political tensions of the Middle East, will test the Bush Administration's mettle every step of the campaign. So market watchers aren't expecting investors to react with gusto every time a Taliban command and control center is taken out. "The average consumer thinks, 'I sure hope our conventional army has learned to fight this unconventional war,'" says Sam Stovall, Standard & Poor's senior sector strategist. Whereas the bombing campaign in Iraq more than a decade ago quickly achieved the immediate goal of forcing Saddam Hussein out of Kuwait, eradicating global terrorism will clearly take more resources and time.

UNSAFE HAVEN? If anything, military actions might add to the sense of uncertainty and the feelings of vulnerability on the home front. This domestic danger factor is something that U.S. markets have never had to deal with before. "Even though strikes have taken place [in Afghanistan], I don't think anyone would be surprised if terrorists struck back in the U.S. I think investors are preparing themselves for that," Stovall says.

That uncertainty extends to investors' willingness to put their assets in the U.S., traditionally the safest of havens for overseas money. "What has changed is the sense of the U.S. being a nice, secure place where investments have a small amount of variability compared to rest of world," McKelvey says.

Larry Wachtel, market analyst at Prudential Securities, expects that if the war drags on, it will probably drift into the background of investors' concerns. Rather, the markets will look to how the economy is faring as it struggles to emerge from an accelerated downturn. "The military factor is important," says Wachtel, "but it's a sidebar to the basic problem of the market: When do we get out of recession and see profits pick up?"

HARD EVIDENCE. Investors will be looking for tangible results that interest rate cuts by the Federal Reserve and an economic stimulus plan are working -- in the form of improved corporate earnings reports and solid economic news, Wachtel believes.

The worst-case scenario? Another attack -- here or against one of America's allies. But in the meantime, news of military assaults day in and day out aren't likely to do much to boost the markets. In this war, the U.S. and its allies will have to show that they have ended the terrorists' operations and restored stability and certainty to capitalism.

As much as Americans might cheer the killing or capture of bin Laden, only a prolonged period without another domestic attack will fully restore market confidence. By Amy Tsao in New York


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