Geopolitical worries weigh on stocks. Is the fear overdone, or will it keep dogging the market?
May 17, 2004: 1:24 PM EDT
By Mark Gongloff, CNN/Money senior writer
NEW YORK (CNN/Money) - Contrary to popular belief, the curse "May you live in interesting times" may not be Chinese, and it may not be ancient.
But it's still apt, and U.S. stock prices reacted poorly Monday to a whole lot of interesting news.
Now the question facing Wall Street is did the selling go too far, or are there really reasons to worry?
It's something of an understatement to say that geopolitical tensions have been high lately. Monday's headlines were par for the course:
A suicide bomber killed Iraqi Governing Council President Izzedine Salim;
U.S. officials are talking about moving some troops from South Korea to Iraq;
New articles in the New Yorker and Newsweek suggested that Bush administration officials may bear some responsibility for prisoner-of-war abuses in Iraq;
Indian markets were roiled by the prospect that a new Indian government will reverse the business-friendly policies of its predecessor;
China's government -- which has already made some investors nervous with talk of cooling down the country's economy -- blasted Taiwan's president and warned it would "crush" any efforts at Taiwanese independence;
Ignoring the war?
Stocks haven't responded much, at least not right away, to key events in Iraq
Date Event S&P 500 percent change
Aug. 19 2003 Bomb at UN headquarters +0.3
Oct. 27 2003 Car bomb kills 30 +0.2
Dec. 15 2003 Saddam Hussein captured -0.6
Feb. 10 2004 Truck bomb kills 50 +0.5
Mar. 31 2004 4 private contractors killed in Fallujah -0.1
Apr. 21 2004 Car bomb kills 68 +0.5
May 11 2004 Video of Nicholas Berg beheading posted on Web +0.8
* Dec. 15 was first day of trading after Hussein's capture
Source: CNN/Money
Explosions rocked Ankara and Istanbul just days ahead of British P.M. Tony Blair's visit to Turkey.
Meanwhile, oil prices continued their steady march upward, with the NYMEX's near-month contract setting yet another record. And there were signs of inflation in other U.S. prices. And interest rates are set to rise any day now.
How's that coffee sitting on your stomach? U.S. markets seemed to be feeling some reflux, selling off sharply Monday. Safe-haven Treasury bonds rose.
But, as they often have lately, many analysts dismissed all the worry. Geopolitical woes come and go, but only three things have a long-term impact on the market: earnings, earnings and earnings, they said.
"These are things that people can be nervous about and, yes, they're concerns," said Ken Tower, chief market strategist at CyberTrader. "But let's face it: the world has trouble almost every day. It's probably not a major factor for our market."
Of course, the risks are tremendous. If recent terrorist attacks in Saudi Arabia, the world's biggest oil producer, are the first stage of greater unrest in that country, then oil prices could be about to spike dangerously high.
If China's slowdown is not as orderly as most economists think it will be, or if China ends up forcibly preventing Taiwanese independence, then things could get uncomfortably interesting in a hurry.
"Geopolitical tensions are on the rise and could at some point in the future have a very negative impact on the global economy and financial markets," economist and contrarian investor Marc Faber wrote in his latest edition of "The Gloom Boom & Doom Report," a monthly investment newsletter.
Is war good for stocks?
On the other hand, bad news doesn't necessarily means stocks have to fall, according to David Kotok, chief investment officer of Cumberland Advisors.
"I hate to say it, but war is good for stocks," Kotok said.
Kotok and other analysts point out that war spending typically boosts economic growth. It had that effect in the first quarter, adding 0.66 of a percentage point to the 4.2-percent annualized rate of gross domestic product (GDP) growth.
"War breeds inflation, as the government borrows money and spends it on non-productive consumption -- tanks, bombs, security devices and x-ray machines," Kotok said. "It is massively stimulative."
Though the market is worried that recent signs of incipient inflation will push the Federal Reserve to raise interest rates soon, Kotok pointed out that the Fed patriotically kept interest rates super-low during World War II, when inflation and government spending were through the roof.
But the twin U.S. trade and budget deficits were record high, as a percentage of GDP, in 2003, and continued defense spending could send them higher, increasing U.S. dependence on foreign investors.
"War can be good for getting you out of recession, but the requirement to keep spending after you're out of the recession is inflationary and not good for the economy," John Davidson, CEO of PartnerRe Asset Management, said earlier this month.
And though government spending would likely pick up even more if the worst should happen -- another war or a terror attack on U.S. soil, for example -- few analysts doubt the global economy and markets would suffer, especially since they're only now recovering from the last prolonged downturn.
"Borrowing from physics, the last thing an unstable system needs is a shock," Stephen Roach, the relentlessly bearish chief global economist at Morgan Stanley, wrote in a note to clients on Monday. "And yet the risks of just such a disturbance have never seemed higher. Far-fetched as it seems, the possibility of a more perilous endgame is rising."
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