The Latest On The War With Iraq

October 29, 2002

IN THIS ISSUE:

1. The Latest On The War With Iraq.

2. Has Bush Caved To U.N. Pressures?

3. Bush On The Campaign Trail – A Mistake?

4. The Economy – More Bad News.

5. Is A Recession A Foregone Conclusion?

What’s Up With The War On Iraq?

The Bush administration has been very tight-lipped about its latest plans for Iraq in recent weeks. Sure, President Bush has been on the campaign trail where he continues to emphasize the need for regime change in Iraq, before Saddam can develop nukes. But there has been very little information made public about when such an attack might begin.

That leaves us to wonder if the US is quietly preparing for an attack on Iraq in January or February, with or without a UN resolution, and keeping that information close to the vest. Or has the Bush administration succumbed to the domestic and international pressures to get the UN resolution before moving militarily against Iraq?

Those who are in favor of attacking Iraq are frustrated, while those who oppose such action are, for the most part, quite pleased that the administration appears to have been sucked into the UN black hole. Some in the anti-war crowd now feel that the Colin Powell faction in the administration that opposes the war has prevailed, at least for the time being. But is that what is really going on behind the scenes in the Bush administration?

My point is, we just don’t know. Given that, here are a couple of scenarios for what may be happening.

The UN Scenario

To most observers, it appears that Bush has given in to political pressures to get a UN resolution. If so, this is a big shift from Bush’s hard-line position when he spoke to the UN on September 12. If you recall, Bush chided the UN for not enforcing its own resolutions against Iraq, and stated that the US would move against Iraq with or without a resolution. In recent weeks, however, the president has not been so forceful. The question is, why?

It seems quite clear now that the US is not going to get the resolution the Bush administration submitted to the UN. If a resolution is forthcoming, it will almost certainly be the France/Russia version, which calls for weapons inspectors to return to Iraq prior to any military action. Those who are in favor of the war are disgusted by this prospect because they believe a new weapons inspection program will be another colossal failure, which will only give Saddam another year or longer to develop weapons of mass destruction. I tend to agree.

However, Stratfor.com, one of my best sources for geopolitical analysis, sees it somewhat differently. Here is their latest analysis of what is happening:

“The U.S. proposal [in the UN] calls for automatic military action if Iraq does not comply with the resolution; a Franco-Russian proposal calls for a second vote if Iraq does not comply. In either case, Washington is indicating that it will proceed with the war regardless of U.N. resolutions. Obviously, Washington would prefer to have a resolution, but the only one it is going to get is the Franco-Russian proposal. In the end, the Bush administration can live with that proposal if there are quiet side understandings about how everyone will vote in the event that Iraq fails to comply. But the United States wants to project a sense of edginess about the lack of progress [in the UN] and on Monday signaled its impatience.

In point of fact, the United States is in no real rush. It is not ready to go to war quite yet, and the extended debate actually allows Washington to position itself more effectively and gives it more time to pressure potential allies to cooperate -- while hoping that cooperating allies don't have second thoughts. Washington needs time to put this together; still, it wouldn't do to look as if it needed time. Therefore, knowing full well that a sense of urgency will be noted in Iraq while having no effect at the United Nations, the Bush administration put on a fine performance, led by White House spokesman Ari Fleischer.”

As you can see, Stratfor believes that the Bush administration is actually pleased with the delays in the UN, even though that is clearly not consistent with what the president said in his speech on September 12 and afterward. If this is correct, it could be well into next year, or even longer, before any military action is taken against Iraq, if at all.

Attack In January Or February

The other scenario goes as follows. The Bush administration intends to attack Iraq with or without any UN resolution, probably in January or February. Some troop and equipment movements have already begun in the Middle East, and more will follow in the remaining weeks of this year. Defense Secretary Donald Rumsfeld has suggested, and many believe, that the US will use a much smaller force to attack Iraq this time as compared to the Gulf War. A more “high tech” war, if you will. If this is true, that could explain why we have not seen major troop movements to the region.

Under this scenario where the US is committed to the war, with or without a UN resolution, it might make good sense that the president is out on the campaign trail trying to win Republican control of the Senate, rather than staying in Washington to concentrate on the plans for Iraq. More than a few observers have criticized Bush for focusing on the election rather than the War On Terror. Yet if the plan is to attack Iraq early next year, Bush would be in a far stronger position if Republicans control both houses of Congress.

Obviously, I don’t know which, if either, of the two scenarios above is correct, or if there is a completely different plan in the making.

Is The Bush Administration Making A Mistake?

Whatever the plans for Iraq, there are those who believe the Bush administration is making a key political mistake by having the president out on the campaign trail. According to the latest Fox News survey of October 22-24, Bush’s job approval has slipped from 69% in August to only to 60% today. His personal favorability rating has dropped to 62% from 72% in August . (I should point out that while Bush’s ratings have dropped, these numbers are still quite strong.)

More importantly, there are those who believe that by campaigning for Republican candidates around the nation, Bush is undermining the case for a military emergency requiring immediate action against Iraq. The latest Fox News poll asked, “which issue will be the most important in deciding your vote for Congress this fall,” and voters cited the economy 25%, terrorism 17%, education 14%, health care 13%, Social Security 11% and Iraq at only 5% percent. Meanwhile, public support for the war against Iraq has slipped from 72% to 62% in the last two weeks.

On this note, it appears that Bush is getting the message. In his campaign speech in Denver on Monday, the president was once again adamant that regime change in Iraq is inevitable, with or without a UN resolution, and that it is only a matter of when, not if.

Conclusions

There aren’t many, at least at this point. It is unclear if the Bush administration is going to stand by, perhaps indefinitely, while the UN debates ad nauseam on new weapons inspections and a watered-down resolution. It is similarly unclear if the Bush administration is intent on attacking Iraq soon after the first of the year, with or without a resolution.

Most of my sources believe it will be the latter scenario which will unfold early next year. If this is the case, we will need to see more evidence of troop and equipment movements into the Middle East between now and the end of the year.

Whatever happens, I expect the investment markets to continue to be very volatile through the end of the year. As public perceptions on developments in the war with Iraq change, the markets will likely have additional powerful swings, in both directions, in the weeks ahead. Stocks, bonds, oil and other war-sensitive markets may be buffeted in both directions, depending on the news on the war.

The Economy – More Bad News

Speaking of President Bush’s approval ratings, he has to be concerned about Americans’ perceptions on how he’s handling the economy. Bush’s approval ratings on “managing the economy” have fallen from 64% approval on April 30 to only 48% on October 22. This may also be partly due to perceptions that the president should be in Washington dealing with the ailing economy and the war, rather than campaigning for Republicans.

Just to review, the economy grew at an annual rate of 5% in the 1Q and 1.3% in the 2Q according to the Commerce Department’s reports on gross domestic product (GDP). The first GDP report for the 3Q will be released on Thursday morning. The Commerce Department hints on its website that the 3Q estimate may be around +2%.

The Index of Leading Economic Indicators (LEI) has now declined for four consecutive months, down 0.2 in September. The Institute for Supply Management Index (ISM), which gauges manufacturing output, fell in July and August and is expected to have declined again in September (report to be released on Friday).

Consumer confidence continues to fall. The Conference Board’s Consumer Confidence Index fell sharply to 79.4 in September. The University of Michigan’s Consumer Sentiment Index dropped to 80.6 this month, the lowest level since 1993. The percentage of households reporting that their financial situation had worsened was the highest in a decade.

Not surprisingly, consumer spending has declined. Retail sales declined 1.2% in September. Sales of “big ticket” items fell off as well as durable goods orders which plunged 5.9% in September. All of this does not bode well for the 4Q. Retailers are said to be preparing for a disappointing holiday season. It remains to be seen if economic growth will fall into negative territory in the 4Q. I would say the odds are 50/50 at this point.

Most mainstream economists, however, continue to believe the economy will remain in positive territory in the 4Q. Then again, mainstream economists, as a group, tend to be on the optimistic side. For example, the latest survey of economists finds that the average expectation is for 3Q growth of 3.7% (annual rate). That is well above what the Conference Board expects to announce later this week.

While we expect a positive 3Q GDP number on Thursday, it may fall on deaf ears. Based on the consumer confidence numbers above, most people expect the economy to worsen in the 4Q. It remains to be seen if growth stays marginally positive in the 4Q, or if it dips marginally into negative territory. The bottom line is, things won’t feel much different whether the economy is +1% or –1% in the 4Q.

Return To Recession?

A recession is widely defined as two or more consecutive quarters of negative GDP growth. The gloom-and-doom crowd would have you believe that the US economy is headed into a severe deflationary recession, or even worse – but then they always do! While the latest round of economic reports were not positive, it is too early to suggest a long, severe recession.

As noted above, I put the odds of dipping into another recession at 50/50. However, I do not see evidence that it will be a long or severe recession, if in fact we do dip into negative growth. As discussed below, monetary policy is very stimulative, with interest rates at 40-year lows in some cases, and the Fed will cut rates even further if necessary to avoid a serious recession. Likewise, the Fed is dead-serious about keeping deflation in-check.

The Fed’s Next Move

The Fed Open Market Committee (FOMC) meets again on November 6 to set monetary policy. Most analysts expect a quarter-point reduction in the Fed Funds rate. Some are even arguing for a half-point cut (50 basis-points) to help jump-start the economy. The Fed left rates unchanged at its September FOMC meeting, but the minutes revealed that several members argued in favor of cutting rates at that time.

The Fed’s position for most of this year has been that with the Fed Funds rate at 1.75%, interest rates are sufficiently low to spur an economic recovery. Normally, this would be true. However, with a weaker than expected global economy and growing deflationary forces around the world, it will be harder for our economy to rebound.

Look for at least a 25 basis-point cut in the Fed Funds rate on November 6. If the economy remains weak, look for another rate cut in December and more next year if necessary.

Stocks – Should I Get Back In?

We have been deluged with this question over the last couple of weeks. The S&P 500 Index soared 16% from its low on October 10. Most investors are wondering if we have seen the bottom. It is impossible to know for sure, no matter what your broker or financial advisor tells you.

Economic news is not good, as discussed above, and stocks are still pricey based on P/E ratios and other measurements. At the least, I expect we will see a retest of the lows seen earlier this month. As a result, I would not chase this rally at this point.

Happy Halloween, everyone!

Best wishes,

Gary D. Halbert

P.S. Due to the elections next Tuesday, I will send Forecasts & Trends E-Letter out a day later than normal. That will give me time to include some election analysis and possible market implications. In the meantime, be sure to vote!

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