Resolution of Conflict

As war talk grows louder and likely dates of conflict crystallize, investors find it hard to focus on anything else.  The amazing thing is the prospect of it seems to carry new emotional impact daily.  Its rather compelling proof that markets can be just as emotional as the individuals who comprise them.  

The economy is doing relatively well in spite of it all.  The week started with a report from New York, that their manufacturing index rose to a surprising level of 10.6.  Economists expected it to fall to 6.  Inflation remains tame as demonstrated by a month over month number of .1% and a year over year of 2%.  Real earnings increased during November by .2%, keeping the consumer healthy.  Housing starts in November rebounded from a disappointing October.  Industrial production and capacity utilization demonstrated that the manufacturing sector continues to struggle with slow growth, but there is growth.

Both imports and exports fell during October.  The latest report showed imports of capital goods declined 2.4% during the month to the lowest level since August 1998.  Exports fell 1% from September.  The drop was due to fewer exports of capital goods and autos.  These trends echo the problem with manufacturing in general, but were likely exacerbated by the west coast dock strikes.

Just released this morning, Gross Domestic Product increased 4% in the third quarter, led by continued consumer spending.  The proof of expansion continues to be in the economic releases, if not the stock market, which continues to worry over the likelihood of war with Iraq.

In a speech to the Economic Club of New York, Alan Greenspan said, “Any significant fall in the current geopolitical and other risks should noticeably improve capital outlays, the indispensable spur to a path of increased economic growth.”  Translated, he means that once the threats of a potential war with Iraq and accompanying terrorist attacks are removed, business spending should improve and boost economic growth.  He indicated that low interest rates remain necessary to keep the expansion going so long as tensions persist and low stock prices drag on the economy.

Greenspan said, “Strong growth of labor productivity, supplemented by reduced tax payments, has provided a boost both to incomes and spending.”  He said the “elevated” ratio of household debt service to incomes is “not a cause of significant concern.”  Consumers should be able to supplement incomes and reduced debt service through mortgage refinancing, which will probably continue into 2003.

He noted that business balance sheets are improving as the cost of capital is down and companies gain easier access to commercial and bank loan markets.  He went on to add that the U.S. economy was not even near the danger of a deflationary spiral, but “never having faced it before we’re [the Fed] looking at it in a way far more intensely than we look at inflation that we’ve experienced on many occasions.”  In other words the Fed remains super vigilant and ready to act if and when necessary.

The stock market is still very nervous, but it is gradually coming to accept that the economy is rebounding.  Volatility is declining and selling pressure is abating.  Bad news from a single company no longer has the full market impact it did in the late summer and fall.  Volatility in the thirty stocks of the Dow Jones Industrial index has fallen from a peak of 57% at the end of July and 49% in mid-October to a current level of 20.5%.  The broader S&P 500 is a mirror image of the Dow.

As we have discussed for weeks, the likely war with Iraq keeps a lid on the market and on global economic expansion.  But the day of reckoning is growing nearer.  The climatic window of opportunity for invasion is during the winter months.  The U.N. Inspections team has set the end of January for their next report to the Security Counsel.  President Bush and his cabinet have indicated they believe they can convince the UN by that time that war with Iraq is the only course of action possible to accomplish the U.N.’s objectives of removing Iraq’s nuclear threat.  It looks like resolution will come by the early part of next year.  After that, the market will likely turn the majority of its attention to the expanding U.S. economy as well as pockets of expansion in other areas of the world.

We wish you and yours the very best this holiday season, that you have a peaceful and joyous time of celebration with the ones you love.  It is also our hope all nations come to embrace the notion that “all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty, and the pursuit of Happiness.”