Why stock market shifts in sync with war in Iraq

Military commanders talk about the "fog of war." On Wall Street, the war has resulted in a fog for investments as economic news is now secondary to battlefield developments on the Iraqi sands.

The emphasis on war news now means that stock traders look over their shoulders at television screens showing images of jet fighters taking off. MBAs are studying maps of Iraq as well as balance sheets. Some Wall Street firms are listening to retired generals explain the meaning of military moves. And some traders are turning to websites run by war buffs who provide almost instant analysis of the military thrusts and feints.

It all shows how enmeshed Wall Street has become with the war - and why the stock market at the moment is as volatile as the grit-laden weather of Iraq.

While conflicts have always driven fluctuations in the stock market, analysts say the psychology of Wall Street today is more intimately attuned to the day-to-day developments in the war than perhaps at any time in the past.

That's because news about the war is so ubiquitous - and it's news that investors believe will impact not only the direction of the faltering economy, but also the status of the US in an energy-driven world.

"The prospect of war and Iraq were a large driver for many months, but now with it really happening, it has become almost the sole factor driving the market," says Scott Jacobson, an investment strategist at Jefferies & Co. in New York.

Recent gyrations show just how much the market is patterning the war. The day after the war started, investors bid stocks up as reports came in that the US may have killed Saddam Hussein, his sons, and some of the top Iraqi leadership. Once it started to look as if Mr. Hussein had survived, the market sold off.

All this has created unusual volatility. Overall, the market last week had its best week in 20 years as the Dow Jones Industrial Average soared 662 points. But on Monday, the Dow dropped 307.29 points. On Tuesday, the market turned around yet again, with the Dow rising 65.55 points.

"There is a lot of angst going around: It's hard to find the proper guidepost," says Duncan Richardson, chief equity investment officer at Boston-based Eaton Vance, which manages $14 billion in stock investments.

Of course, this is not the first time the markets have reacted to war news. In 1972, during negotiations to end the Vietnam War, the market soared when rumors swept the trading floor that "peace was at hand." Later, when the rumors were denied, stocks fell.

During the first Gulf War, investors were tuned into CNN. But this time, it's quite different. Television crews are traveling with military units, and retired generals are interpreting the information immediately.

In addition, investing itself has somewhat changed, as many more Americans are keeping close tabs on stocks.

"Everything is accelerated, and the transmission of information is so much faster," says Jay Mueller, director of fixed income at Strong Capital Management in Milwaukee. "This means that some of the lessons investors learned from the first Gulf War can be applied more quickly."

They are also getting some help. For example, Charles Schwab's Washington Research Group has lined up retired Air Force Gen. David "Bull" Baker to help clients. "He's been very useful, helping us parse some of the language and understand what to expect," says Mr. Mueller.

Some institutional investors have their own battle plans to deal with the market's volatility. That's the case with Houston-based Mark Roach, comanager of the CDC Nvest Large Cap Value Fund. "My strategy is to buy on down days and not get caught up in the emotion," says Mr. Roach, who then sells on up days when he has a 15 or 20 percent gain.

He thinks the market will continue like this for a while. "If I had to make a guess about the market, I would say we'll be traveling a lot of distance up and down. But in the end, we will not have gone anywhere."

This kind of volatility is keeping many individual investors on the sidelines, if not out of the market. "Basically what you see is investors taking money out of equity funds and putting it into bond funds or bank accounts," says Sam Stovall, a senior investment adviser at Standard & Poor's in New York.

This is a change from 1991, when most investors rode out the war. "There has been a lot more psychological damage to investors today," says Mr. Stovall. "We've been suffering through three years of a down market."

This means that investors seem to be ignoring economic news that might buoy the markets. Congress, for example, is moving toward passage of some sort of tax cut that should provide fiscal stimulus. "It should have encouraged investors," says Mr. Richardson of Eaton Vance.

Instead, investors are worried there could be surprises ahead on the battlefield. "Do the Iraqis use chemical weapons?" asks Mr. Jacobson of Jefferies & Co. "If they do, it changes the whole mix. We could see troops from other countries."

Richardson, however, thinks the use of weapons of mass destruction would be viewed negatively by the market. "It takes us into further new ground," he says.

So far, Wall Street is expecting the war to be over relatively quickly. But if it drags on, media attention might turn back to the economy - in terms of how much damage it can sustain from an extended war. "If the war is protracted, it affects consumer and business confidence, and that could ripple through to a double-dip recession," says Stovall.

Whether that happens, however, is far from clear. "The fog of war is being replaced by the humidity of the headlines," says Stovall, "and investors are sweating it out."