The stock market has been on a tear in recent days. On Mar. 17, the day leading up to President Bush's ultimatum to Saddam Hussein, the Dow Jones industrial average posted its biggest gain in five months, rallying 282.21 points, or 3.6%. The day after the speech, the Dow rose again, ending up more than half a percentage point (0.64%) higher. And on Mar. 19, the party continued, with the Dow and S&P up again. All told, in just one week the Dow has risen 9.4%, the Standard & Poor's 500-stock index, 8.7%, and the Nasdaq, 9.2%.
The bad news is that the upsurge -- known on Wall Street as a "relief rally" -- isn't likely to last. True, uncertainty over Iraq has finally been lifted, and investors are betting the war will be quick and effective. The same thing happened at the start of previous wars. When the U.S. went after Iraq in January, 1991, during the first Gulf War, the S&P rallied almost 20% by the time a cease-fire was announced some three months later.
Once this Iraq crisis is past, though, investors will still be confronted with a lackluster economy and tepid corporate earnings. Companies such as Intel (INTC ) and Walt Disney (DIS ) are already warning that their profits may not live up to expectations. "It's tough for the market to sustain an upward move when earnings estimates are continually being revised lower," says John Caldwell, chief equity strategist for McDonald Financial Group in Cleveland.
CONFESSION SEASON. Pessimism, moreover, has been rising steadily. On Jan. 1, according to earnings researchers Thomson/First Call, analysts were expecting first-quarter year-over-year S&P profits to be up 11.7%. By Feb. 1, they had whittled the number down to 8.8%. And by Mar. 14, they were estimating a gain of just 7.8%.
Now, the first-quarter earnings "confession" or "preannouncement" season is under way. That's when companies issue notices that their earnings may or may not live up to analysts' expectations. So far, according to First Call, companies have made more negative preannouncements than at any time since 2001, when the economy was in full recession.
The market could even take a turn for the worse after the confrontation. Renewed terrorist attacks or higher-than-expected casualties, among other factors, could trigger a sell-off, says Seth Scholar, senior research analyst at Sand Hill Advisors in Palo Alto, Calif. "The market is extremely volatile due to the current level of geopolitical risk and is likely to remain that way," he says.
Still, it's unlikely that stocks will stage a sustained recovery any time soon. "Due to the current bear market, I believe the rally will be muted," says Martin Schulz, director of international equity investments for Armada Funds, adding that resolving the Iraq crisis is nonetheless a first step toward economic recovery. And there's the rub. Stocks probably won't stage a strong recovery until the economy does, and economic recovery may take awhile.
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