Stocks rallied nicely in the first few weeks of January, right up to the moment that chemical warheads were discovered. For most investors, this was the wake-up call that war could happen, and stocks sold off 10% to 15% over the next four weeks.
We told our clients early last September, "Pragmatically speaking, given the call-up of armed forces reserves, the prepositioning of troops and materiel in neighboring countries such as Turkey, Jordan and Bahrain, and the fact that factories are on triple over-time producing the kits for 'smart bombs,' it seems that the Administration has already decided on such a war, perhaps in January-March 2003 when temperatures in the mostly desert country are bearable."
To draw conclusions of this nature, I continuously assess the likelihood of possible outcomes. I assign estimates as follows:
1% -- nearly impossible
10% -- very unlikely
25% -- unlikely
50% -- could go either way
75% -- probable
90% -- very probable
99% -- almost guaranteed
For example, to estimate the likelihood of war given current information, consider the following scenarios:
Saddam Hussein resigns and goes into exile: 1%, nearly impossible. Nothing in Hussein's 45 years in power suggests he would step down now.
Hussein is assassinated: 1%, nearly impossible. Hussein has a history of pre-emptively killing off opposition figures. Henchmen whose own survival is doubtful in the event of "regime change" surround him.
The U.S. stands down and returns troops to U.S. and Europe: 10%, very unlikely. If you put a gun to a man's head, you have to be prepared to pull the trigger. To back down now would be an astounding publicity coup for Hussein and would encourage other troublemakers.
There is a last-minute deal from Hussein to disarm: 10%, very unlikely. However, Hussein does define "victory" as his survival in power, and he just might cough up the weapons to avoid being deposed.
I can't think of any other scenarios to avoid war. To calculate the likelihood of war, I subtract the percentages of "no war" from 100%. 100% - 1% - 1% - 10% - 10% = 78%, indicating war is "probable."
William Saletan at Slate.com does a similar daily analysis and tracks the results over time. As of Feb. 21, he places the "chance of invasion" at 95%, up from 50% in early December.
An Ireland-based gambling Web site will let you bet on Hussein's survival (click on the Politics/Current Events tab). As of Feb. 24, punters give a probability of Hussein deposed at 25% by March 2003, 70% by June 2003.
Assessing Motivations
Many in the peace movement and the Arab world believe that this war is about oil. Although Iraq holds the second-largest reserves after Saudi Arabia, it's well down the list of 25 countries currently supplying energy to the U.S.
Hussein would have cheerfully sold the U.S. all the oil Iraq could pump, if only the U.S. had allowed the U.N. to drop sanctions. Iraq's infrastructure is degraded to 20% of capacity, and Iraq apparently plans to set fire to its oil fields once war starts. After Canada, Venezuela is the second-largest supplier of energy (oil and gas) to the U.S.; it would be more logical to invade Venezuela if oil were the only motivation. I assess "oil" at 10% -- very unlikely.
Personal vendetta by Bush 43 on behalf of Bush 41: 1%, nearly impossible. Even if this were true, which I doubt, I can't imagine that the Joint Chiefs of Staff would sign on to such a venture.
War as "humanitarian effort" on behalf of Iraqi people: 10%, very unlikely. The U.S. and U.N. have cheerfully ignored humanitarian disasters in Africa (particularly Rwanda), Cambodia, North Korea, and China during the Cultural Revolution. The U.S./European intervention in the civil wars of former Yugoslavia (Serbia, Bosnia, Croatia, Kosovo) marks one of the few times of military intervention to protect civilians, and that happened only after the massacre of tens of thousands.
War on Iraq is part of the antiterrorist campaign. The link between Iraq and al Qaeda remains unproven. However, there's information that Iraq has shipped weapons and scientists to Syria and Libya, and a definite concern that biological, chemical and missiles are floating around, possibly falling into terrorist hands. Iraq is a California-sized country in the center of the Middle East, bordered by six countries. Seizing and garrisoning Iraq would allow U.S. forces to monitor and disrupt terrorist activities throughout the region -- it's not just al Qaeda we have to worry about. I rank this motivation at about 75%: very probable.
The U.S. administration claims troops would be withdrawn and Iraq turned over to a civilian government within two years. Given that U.S. troops remain in Germany 58 years after World War II, in South Korea 50 years after the Korean War armistice and in Saudi Arabia 12 years after the first Gulf War, I rate this claim at only 10%: very unlikely.
Additional Assessments
Discovery of "smoking gun" by U.N. inspectors in the next four weeks: 25%, unlikely. Although plenty of information from defectors, previous U.N. inspections, spy satellites and phone intercepts suggests that Iraq has hidden biological and chemical weapons, aside from some unloaded chemical shells, suspicious "rocket" tubes that could be for extracting uranium and 300 missiles with greater than allowed range, the inspectors have reported finding only less than enthusiastic cooperation.
U.N. approves second resolution authorizing war: 50%, could go either way. The Feb. 14 inspectors' report was unexpectedly ambivalent -- the Iraqis have cooperated just enough to convince some that inspections are working. Two resolutions were introduced on Monday -- the first from the U.S., U.K. and Spain declaring that Iraq was in material breach and should face serious consequences within two weeks.
The second resolution from France, Germany and Russia proposes to enlarge and extend the inspection process for an additional four months. Neither proposal has much chance of clearing vetoes from the permanent members of the Security Council, let alone attaining a majority vote. The problem is, the U.S. can't wait much past March 15 before the increasing heat and length of deployment starts degrading military effectiveness.
Use of chemical and biological weapons by Iraq once the war starts: 90%, very probable. Perhaps the most telling information is that chemical weapons suits were issued to Iraqi soldiers and members of the elite in recent weeks. Iraq did not use such weapons in the first Gulf War because the U.S. threatened to retaliate against Baghdad with nuclear force if such weapons had been used.
The Iraqi army collapses within days or weeks: 50%, could go either way. In the first Gulf War, Iraqi forces were routed from Kuwait after 100 hours of ground combat. However, forces occupying Kuwait were poorly trained, poorly armed conscripts with little desire to hold territory or fight back.
This time around, I can see U.S. forces rapidly taking southern, western and northern Iraq but getting bogged down around Baghdad. Hussein has drawn in the Republican Guard -- the elite Iraqi forces -- and positioned units among the civilian population. Rifles and ammunition have been distributed to most adults. Just rent Black Hawk Down to see how horrible fighting in such an environment could be.
It's quite straightforward for U.S. forces to surround Baghdad, cut off the electricity and water supplies and starve out the defenders, but that outcome would be a public relations disaster. Also, Iraqi troops would be fighting on home territory, which might stiffen their resolve.
Further small- and medium-size terrorist attacks: 99%, practically guaranteed. Terrorists have launched attacks against U.S. interests for more than a decade (the first World Trade Center attack, USS Cole, American embassies in Africa, Saudi Arabian barracks, etc.). Since the Sept. 11 attack, there have been a dozen additional attacks, including a bombing of a French tanker, an attack on French engineers in Pakistan, 200 killed in Bali, a hotel bombing in Nairobi (and a failed attempt to shoot down an Israeli airliner) and assorted assassinations throughout the Middle East.
Large-scale terrorist attack on the order of Sept. 11 (3,000 killed, $50 billion in economic damage): I can't estimate the probability on this one. In many ways, the simultaneous hijacking of four airliners without detection was a once-in-a-generation lucky shot. But it's too early to say whether counterintelligence efforts worldwide would prevent a similar large-scale attack.
Utility for Investors
Traditional investment analysis is almost useless in the current environment. The most recent round of earnings reports were fine, growth of 12% year over year, and about 3% higher than expectations according to First Call. However, company managements could give little insight into results for this quarter and the coming year.
If you are a CEO contemplating building a factory, rolling out a new product, hiring a thousand employees or starting a marketing campaign, you will probably postpone that decision until April. Investors don't know what to do either -- daily volume on the New York Stock Exchange is running about one-third lower than last fall, and AMG Data reports that money flowed out of U.S. equity funds in December, January and February.
However, the S&P 500 is undervalued by 25% to 40% according to the Fed Model. In March 2000, General Electric
(GE)
had a P/E over 45 and a yield under 1%. At current levels, General Electric trades with a P/E of 16 and a yield of 3.2%, or a third of peak valuation, and could be a bargain.
A Note About Precision
These assessments are highly prone to error due to qualitative judgments and incomplete data. Therefore, ranges of probability (e.g. 10% to 20%) are more useful than single numbers (e.g. 11%).
A Note About Sources
Look back at my column Line Up Your Sources for the War in Iraq. Additional sources include www.Debka.com, an Israeli site with one-third news, one-third notable scoops and one-third unconfirmed rumors. www.ArabicNews.com, an English language Web site, conveys the anger and despair of the Middle East toward the West. Al-Jazeera, the Arab world's CNN, will shortly launch an English language version of its Web site. Stratfor has broken out its Iraq war coverage at a new Web site www.US-IraqWar.com for a 12-month subscription of $49.95.
Click here to read a letter about this story.David Edwards is a portfolio manager and president of Heron Capital Management, a New York management firm. Edwards was a contributor to Harry Domash's Fire Your Stock Analyst: Analyzing Stocks On Your Own available at Amazon. At the time of publication, his firm was held positions in General Electric mentioned in this column, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Edwards appreciates your feedback and invites you to send it to David Edwards.
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