For the first time in months, U.S. forces seem to have the upper hand in Iraq, moving two days ahead of schedule to transfer power to Iraqi authorities and catching insurgents off guard.
But after the positive shock of the largely ceremonial handover of power wears off, the situation in Iraq is expected to remain much as it has been for the past year. Violence will continue, U.S. soldiers will die, financial costs will continue to rise, and Bush's re-election chances will remain cloudy. For all of these reasons, U.S. stock investors need to greet the transfer of power with a healthy dose of skepticism and caution.
Earlier this month, the U.N. unanimously approved a resolution to return power to the Iraqis by the end of June. U.S. officials tried to catch Iraqi insurgents off guard by making the transfer today, two days ahead of schedule.
The U.N. resolution also legitimized a U.S.-led multinational force, which will serve "at the request of the incoming interim government of Iraq." The interim government will serve until national elections are held in December or January of next year.
Some analysts believe the transition will be a positive development for stock investors, because it means the U.S. will no longer be considered an occupying force, something that has proven costly in both financial and human terms.
If we can put Iraq into the hands of Iraqis, it's a better scenario, because right now it looks like us vs. them," said Quincy Krosby, chief investment strategist at The Hartford Financial Services Group. "This makes it more their situation."
Still, many people say the U.S. will remain in control of Iraq after June 30 and that international involvement will probably be limited. More than 130,000 U.S. troops are expected to stay in the country after the transition, and Deputy Defense Secretary Paul Wolfowitz said those troops could be there for several years.
"Nobody takes seriously this so-called handover," said John Edmunds, professor of finance at Babson College in Massachusetts. "Everyone knows America runs Iraq and will run Iraq until we're no longer in Iraq."
Analysts say car bombings and other random acts of violence are likely to remain a way of life in the region for some time to come. Indeed, Gen. Peter Pace, vice chairman of the Joint Chiefs of Staff, told Congress this week that he expected more violence, not less, after sovereignty is returned to the Iraqis.
Of course, investors have become inured to all this aggression since the war began more than a year ago. The gruesome beheadings of Americans Nicholas Berg and Paul Johnson and South Korean Kim Sun-il had little impact on investor psychology, and attacks on U.S. soldiers have largely been shrugged off. On Sunday, there were reports on Arab TV that militants have taken two new hostages, including a U.S. Marine. The insurgents reportedly are threatening to behead them if their demands to release prisoners are not met.
Brett Gallagher, chief investment strategist at Julius Baer, said events in Iraq are far less important to the market these days than what happens with interest rates and earnings.
"The effect on the market overall is very minimal," he said. "Is what's going on in Iraq going to influence the number of routers a company buys or the number of digital cameras the consumer buys? The answer is no."
Still, ongoing turmoil in Iraq could influence the upcoming election, which is something Wall Street does seem to care about.
If headlines continue to look dire after the handover of power, support for President Bush could dwindle. An
poll recently reported that for the first time, more than half of Americans do not believe the Iraq war was worth fighting.
Many traders on Wall Street are concerned that if Bush does not win the election in November, his opponent, John Kerry, might roll back Republican tax cuts on dividends and capital gains.
Other pundits note that the financial costs of reconstructing Iraq are mounting, and could be harder to ignore going forward.
"The only reason
Iraq makes a difference in the stock market, regrettably, is not because of the people getting killed but because of the money that is being
frittered away," said Edmunds.
The House and Senate recently approved defense spending bills that include $25 billion for U.S. operations in Iraq and Afghanistan, and many see that as just a first installment.
President Bush approved spending bills amounting to $150 billion last year to pay for the war and reconstruction of Iraq. That's more than three times what the White House originally estimated, and it has helped contribute to a huge fiscal deficit.
Since overseas central banks continue to buy U.S. government debt, the deficit hasn't prompted a significant backup in long-term interest rates. But some economists say this could change. The International Monetary Fund published a report earlier this year saying large budget deficits pose "significant risks" for the American economy and the rest of the world.
"The more important long-term effect on our stock market is the issue of paying for the costs of the war," said Bruce Fenton, president of independent investment firm Atlantic Financial.
While Iraq's huge oil reserves could allow it to finance its own redevelopment in the future, some pundits say big investments are needed in the country to open untapped oil fields. Expectations for an influx of Iraqi oil onto world markets have proven unrealistic so far and the nation's facilities are still in danger of being attacked by insurgents.
"The stock markets do not like uncertainty, and uncertainty will remain in the region and the world long after the handover," Fenton said.
Michael Panzner, author of the upcoming book
The New Laws of the Stock Market Jungle: An Insider's Guide to Successful Investing in a Changing World
, agrees that the transfer of power will not reduce the level of geopolitical risk in the financial markets.
"The handover does not actually appear to be a 'disengagement' from Iraq," he said, calling the handover paradoxical. "It will eliminate one uncertainty, but it will uncover a myriad of others."