The Recovery: War is Only the Beginning

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WHERE'S THE RALLY? War uncertainties are keeping the markets down

With the markets sagging, unemployment still high, and the Commerce Department reporting Thursday that economic growth sank to a paltry 0.7 percent growth in the last three months of 2002, there?s little question that the long-awaited recovery of 2003 is still stuck at the starting line. ?The economy is in a holding pattern because of Iraq,? says Gus Faucher, senior economist at ?The higher price of oil is putting a pinch on fuel-intensive industries, and other businesses are reluctant to invest until some of the uncertainty clears up.? The Fed concurs, explaining Wednesday that its interest-rate hands were tied because ?Oil price premiums and other aspects of geopolitical risk have reportedly fostered continued restraint on spending and hiring by businesses.?

That?s why the prospect of a successful war in Iraq — one that?s at least as short and as easy as the first Gulf War, and ousts Saddam besides — has economists thinking catalyst. ?A war will definitely have a cleansing effect,? Faucher says. ?Once it?s over — and presumably then we?ll get a stimulus package of some kind — oil prices will come down, and businesses will start investing again. By the second half of the year, assuming we don?t get bogged down in a six- or nine-month war, a recovery should be really taking hold.?

But even if Wall Street greets the end-is-near point of this Gulf War like it did the last one — with a roaring rally — the table of uncertainty won?t be cleared all at once. Even discounting for now some of the more nightmarish scenarios — an outbreak of terrorism worldwide in response to the war, a chemical or biological outburst from a cornered Saddam and the attendant response from the U.S. — few expect a U.S. rebuilding of Iraq to be any less persistently messy than it has been in Afghanistan — and unlike Afghanistan, every tremor in the next Iraq will shake the energy markets, and those fuel-intensive industries, along with it.

The degree to which oil prices, in particular, return to their pre-uncertainty lows ?will depend on the stability of a post-Hussein regime,? Francois Trahan, chief investment strategist at Bear Stearns, writes in a report this week. As for the broader market, ?we would not expect a quick military victory to completely eliminate risks." At best, "it will bring a sigh of relief to equity investors and refocus attention on the fundamental backdrop." A backdrop which still includes the earnings woes and slender profits that beset much of corporate America with or without the uncertainty in the Middle East.

Not to mention the other half of any broad recovery — those beaten-down consumers, who account for two-thirds of the U.S. economy and will in the end be the difference between a quick comeback — in which business activity is met eagerly with demand — and one that only investors can feel. As the fourth quarter showed, consumers may well be done spending until they start getting their jobs back. And that will be a little while.

?Unemployment will probably stay where it is until late in the year. When a recovery is just starting up, companies will merely work their existing employees harder while it takes hold,? Faucher says. ?They don?t start hiring back right away — there?s always a gap there.?

It may be normal. It may be part of any recovery, particularly a recovery from the deep and successive traumas this economy has lived through in the past three years, from the dot-com bubble to 9/11 to the persistent disappointment of a 2002 spent waiting for a recovery that still hasn?t come. In that context, a broad, job-ful recovery by year?s end would be rather impressive, considering the last, jobless one (which surrounded the last Gulf War) took four years to flower. But it still pays to remember that even if the end of the war is the beginning of the recovery, this economy will still have a long way to go.