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Friday, March 21, 2003

Bad Dream, or Real Life Nightmare?

Stephen Roach can't be the only one worrying this week about all the optimism the markets are showing about a past-war economic recovery. My feeling, like his, is that this is very premature. The outbreak of war has released a tension that had been building up for months. Now it has finally arrived, and the market response is a reflection of this feeling. What happens tomorrow, when it is all over, this is anyone's guess. My own feeling is that the hangover of discovering that the problem was something more than geopolitical uncertainty may have negative consequences. But as I've said many times, trying to guess the markets is a fools game.

In just one week, financial markets have gone from despair to hope. Rewarded for leading the battle into Iraq, the US has led the way. With oil prices having plunged by 20%, stocks up 9%, yields on long Treasuries up 40 basis points, and a beleaguered dollar seemingly on the mend, it is tempting to conclude that the angst of a week ago was nothing more than a bad dream. Is it time to focus on postwar recovery?

The answer to that question, in my view, is an unequivocal “no.” While I certainly concede that the jury is out on the great recovery debate, I would argue most emphatically that it is entirely premature for investors to put war and business cycle risks behind them. We’re all taught that financial markets were put on this earth to embarrass as many as possible for most of the time. Yet I would argue that it is truly an extraordinary leap of faith for investors to conclude that American military supremacy will lead to the “perfect victory” -- an outcome that can then be seamlessly translated into economic and financial market vigor. It’s times like this where the analyst has to keep cool and stay focused on fundamentals -- not emotion. As I see it, the market volatility of the past week smacks more of the latter than the former.
Source: Morgan Stanley Global Economic Forum

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