DONALD COXE April 28 2003


DONALD COXE April 28 2003



Wall Street’s optimists see too many parallels between the two Gulf wars


SINCE GEORGE W. BUSH declared that the U.S. was serious about Saddam, Wall Street has been advising investors about the war’s impact on the economy and the stock market. Each week, we’ve been given forecasts about oil prices, inflation, interest rates and the inevitability of a victory-driven new bull market once the war finally got under way.

That the Street, never renowned for its bench strength in serious historians, has been so confident in its forecasting is because it has been using the first Gulf War as its database. That example has many advantages: it is so recent that even the dimmest minds on the Street can actually recall it, it has many of the same names of prominent protagonists, it has the same geography, and it supplies seemingly unshakeable reasons for bullishness.

As we have been told, the Gulf War produced a brief panic leap in oil prices to US$40 a barrel, followed by a collapse. The Dow Jones Industrials soared 1,000 points once the bombing began. The war itself was dazzling, beautiful and short, and the global economy soon began to pick up steam, setting the stage for the best economic and stock market times on record.

With that plausible pitch, the Street has been enthusiastic in its appraisal of the current war as a great reason to buy stocks generally, and a great reason to dump oil stocks. Cheap oil and cheap money will get the economy and stock market moving. Why should investors be skeptical?

One reason is that the people who now tell us the market is cheap were the same ones who told us to buy tech stocks when Nasdaq was trading at 350 times earnings. In particular, we should mistrust the Street when it is citing history. The get-rich-quick stock market books of the 1990s that drew extensively on history enriched only their authors and Wall Street. The books grotesquely abused history through manipulation of stock returns data. (Two-thirds of those nine-per-cent longterm returns came from dividends, which had shrunk to the ridiculous level of 1.4 per

cent in the 1990s.) “Stocks for the long run,” “New Economy,” and other such catch-phrases were, in reality, weapons of mass wealth destruction peddled by shills and mountebanks.

For those who actually want to investigate the history of that era before they invest, here are some relevant points. First, the Gulf War produced the only U.S. current-account surplus in the past 22 years, thereby enriching Washington and propping up the U.S. dollar at a time of a painful U.S. recession bedevilled with banking problems arising from the real estate bust. The Japanese, Germans, Saudis and Emirates paid the U.S. so generously that the Pentagon actually earned a brief profit. This time, the financially challenged U.S. is paying most of the costs of a much more expensive mission, adding substantially to the government and current-

account deficits at a time the U.S. dollar is in a major bear market.

THE STREET SAYS cheap oil and cheap money will get the economy and stock market moving. Why should investors be skeptical?

Second, the first war came at a time of a global recession and weak oil prices. Once the panic buying ended, oil prices plunged, and stayed weak for a considerable time. This time, war came with the global economy strong enough to absorb all the oil actually produced (after allowing for the cutbacks in production from Venezuela, Nigeria and, of course, Iraq). China, formerly an oil exporter, now imports roughly 1.6 million barrels a day. Oil prices aren’t punitively high, but they aren’t cheap, and operate as a tax on consumers in industrial nations.

Third, the Gulf War was a relatively minor geopolitical and economic event compared with the collapse of Soviet Communism. The Cold War’s end smashed the last pillar

of the Age of Inflation, giving birth to the Age of Disinflation, which meant falling interest rates (and rising price-earnings ratios) for the next dozen years. The reunification of Germany triggered the biggest construction boom in decades on the Continent, as Helmut Kohl determined to lift the East from its ruins as a failed socialist paradise. The rush of investment into the East drove the Deutschmark sharply higher against other Continental currencies. (One longterm result Kohl didn’t foresee: the Maastricht Treaty—the spawn of French socialist Jacques Delors—which created monetary union and fixed the mark at a particularly expensive level with its rivals, notably the French franc. This would prove to be a huge, economically painful subsidy to France from Germany over the next decade—by making Germany less competitive and encouraging business investment in France.)

This time, there’s scant stimulus for capital investment across the industrial world. In the U.S., state and local governments, usually major-league spenders on capital investment, are running fiscal deficits, so they’re slashing spending on public projects, including highways and bridges.

Fourth, there was no SARS then. This is the first jet-set-transmitted disease, and it is inflicting economic harm on a bigger scale than the seemingly modest sickness and death statistics suggest. It scares people who have disproportionate influence on economic activity. When business people stop travelling and attending conferences, the whole global economy suffers—not just Hong Kong, Beijing and Toronto.

Finally, the U.S. stock market’s price-earnings ratio back then was roughly one-third lower than today, and stock options were being issued in trivial volumes. Today, not only is the market not cheap, but technology companies continue to issue stock options by the billions, without reporting their costs in earnings, further debasing an already debauched system.

There are good reasons for selective equity investments now (particularly in the oil stocks the Street rejects), but none has anything to do with the stuff the Street excretes. Those who would learn from a misstated account of history are destined to repeat their previous investment mistakes. 171

Donald Coxe is chairman of Harris Investment Management in Chicago and of Toronto-based Jones Heward Investments.