Wall Street has not been kind to investors this week. Rattled by anemic earnings forecasts, weak economic data and the Federal Reserve’s decision to leave interest rates unchanged, the Dow Jones Industrial Average hit a four-year low on Tuesday, while the technology-heavy NASDAQ index also showed losses.
But it is the impending war with Iraq that will truly test the economy’s mettle, experts say.
“In the short run, it is possible that the market will actually react negatively because of the increased uncertainty and tensions this will cause in that region and its implications for oil prices,” Business School Finance Prof. Anjan Thakor said.
The international economy could feel an effect too, he added, noting “everybody is affected by what happens in U.S. equity markets, which account for almost 40 percent of global equities.”
Finance Prof. Nejat Seyhun said he also believed a war could cause detrimental effects to the markets.
“In general, wars do not help economies,” Seyhun said. “In fact, wars do the opposite. They hurt the economy. In addition to the human costs, they divert resources.”
Seyhun said that while the Persian Gulf War cost the U.S. government around $80 billion, a second invasion with fewer allies could “push the price tag to at least a few hundred billion dollars. Moreover, if the U.S. is alone in paying these costs, that will add a second burden.”
Many have claimed that historically, war has proven to help a weak economy, as seen with World War II and the Persian Gulf War. But Seyhun said that in both cases, recovery was an “unintended side effect.”
He pointed out that with World War II, the United States did not have high reconstruction costs to begin with and was the only economy left standing at the war’s completion. With the Gulf War, Middle East expenditures on U.S. arms and lowered oil prices helped the economy move out of a recession.
But both agreed that in the long run, if the U.S. does go to war and successfully completes its mission in a timely manner, the markets would respond positively.
“A reduction in the threat of terrorism will be beneficial for the market,” Thakor said. “Plus, a friendly regime in Iraq that is not subject to sanctions can pump out significantly more oil and reduce Saudi Arabia’s hold on (the Organization of the Petroleum Exporting Countries), as well as its overall prominence in the global economy. This will benefit all oil-dependent economies and boost the stock market because it will lower oil prices and create a more assured supply.”
But Seyhun was quick to point out that a long, drawn-out war with heavy casualties could lead to an “additional, long-run decline in the stock market.”
Aside from war, another factor affecting the market this season is the upcoming Congressional election. The economy is expected to be one of the bigger political issues in campaigns.
This year, embattled investors will be allowed to have the final say – one piece of good news in an otherwise difficult year.