David R. Kotok
Financial predictions during war time
http://www.NewsAndOpinion.com | What if the war with Iraq becomes a long term quagmire? What if the North Korea situation develops into a second front? What if we have another terrorist attack in the U.S.?
We hear these questions all the time. They are the cause of this market malaise.
Finance and economic professionals can measure the measurable. But we cannot easily quantify how such unanswered questions impact the markets. That is the current dilemma for investors in this range bound market.
Here's what we know. We can measure the deficit and the impact of Bush's tax cuts and budget. We can estimate the impact of the form of tax cuts once Congress constructs the legislation. We can estimate the impact of Federal Reserve policy but we have trouble guessing at the timing. We can even guess at the effects of a weakening dollar although the short term movements are very difficult to estimate.
But it is impossible to measure how war fear is keeping people from spending or is inhibiting business from investing for growth. Try to quantify the "frozenness" of a deer looking at the headlights of your car. You have no way to know when the deer decides to bound away.
To make this guess we have to look at normal trends and then estimate how far off they are from normal as we travel through these uncertain times. This a very poor way to guess at the impact of the "what ifs." And what was "normal" then is certainly not "normal" now.
The other thing we can do is base our decisions on the outcome that we expect. Geopolitical expectation about Iraq is clear: the U.S. will prevail militarily and the war will be short. We can pencil that one into our mix.
But markets won't do that which means more uncertainty and volatility until Iraq and North Korea appear to be headed for some more predicable outcome.
We also expect that the pipeline of fiscal and monetary stimulus will eventually work; it always has. But it won't show up in the markets without a lifting of some of the geopolitical fog.
We expect Iraq to be resolved soon; weather patterns in that region suggest the U.S. must act before the summer heat intensifies. Colin Powell will make the case of the smoking gun. Does the report by Saddam Hussein's defecting bodyguard offer the evidence?
North Korea appears to be moving to obtain a bribe; this presents a different problem for Bush. Do we pay bribes like the Clinton Administration did or do we stand strong? The U.S. cannot quickly attack a nuclear armed power with a million man standing army. But America also cannot let it develop a more intense nuclear weapon and missile delivery system either.
There are many who now believe that the North Korea threat is actually more serious than Iraq. We are among them. Either way it will loom on the horizon for a while.
What happens when there is some clarity?
We think the markets will take off like a rocket. The firepower is there.
The idle balances grow daily. Money in the trillions is sitting and earning 1% or so which is less that the present low rate of inflation. Money is correctly reluctant to go into bonds because of fear of higher interest rates in the future. Money is bleeding out of the dollar and into other domains.
Clear up some of the geopolitical uncertainty and those dollars will flow into U.S. stocks. U.S. bonds will be hit hard under this scenario.
In sum, our bond accounts remain defensively structured. We want to preserve the capital value in a bond market sell off; that is the only way it will be intact for redeployment in the higher interest rate environment that is coming. Our equity accounts remain invested in exchange traded funds with great diversification.
And we nervously wait for the geopolitical events to play out.
JWR contributor David R. Kotok is President and Chief Investment Officer of Cumberland Advisors, Inc. His articles and financial market comments have appeared in The New York Times, The Wall Street Journal, Barron's, The Bond Buyer and numerous other publications. He can be seen on CNN, CNNfn and CNBC. Comment by clicking here.
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