Financial markets appear captive to developments in Iraq. Just as optimism about the early successes of allied forces helped propel last week's stellar gains, reports of the first setbacks prompted Monday's sharp selloff.

Still, the war is arguably a sideline event on Wall Street, given nothing that's transpired to date has changed anyone's opinion. Bulls are still bullish and bears are still bearish -- and both are seemingly using war-related issues to justify preconceived views.

For example, Tobias Levkovich, senior institutional U.S. equity strategist at Salomon Smith Barney, has been upbeat on shares for some time now. In a note to clients Monday morning he extolled the positive elements of the conflict, including a rundown of allied military successes. In addition, he noted the sharp decline in oil prices, estimating "as much as two-thirds of the so-called war premium" has dissipated. (Many would argue that point about "war premiums," but crude futures are down more than 25% from prewar highs, even after Monday's 6.5% jump.)

The strategist acknowledged many risks to the optimistic scenario, including that "mop-up operations are proving to be more difficult than previously assumed." He also prudently noted the threats of terrorism and weapons of mass destruction, as well as "other global trouble spots," such as North Korea, Venezuela and Nigeria (not to mention the still-unfinished task of winning the Iraqi campaign).

Still, to bulls such as Levkovich, "the heavy skepticism in any market gains nowadays is one of the key factors that suggest to us the war rally is not over" -- Monday's setback notwithstanding.

Similarly, Thomas McManus, equity portfolio strategist at Banc of America Securities, opined Monday morning that "investors should use dips as an opportunity to boost equity weightings," echoing a view expressed

Friday by Rick Bensignor of Morgan Stanley.

McManus, who's become

increasingly bullish since midsummer, believes the selloff prior to March 12 marked a "successful test" of the July and October lows, predicting "further tests are unlikely."

Furthermore, "equity valuations are more attractive than they might appear at first glance," he argued, citing the median dividend yield as measured by Value Line. Dividend yields -- actual cash outlays divided by share price -- were 2.4% on March 12. That's the highest since March 2000, which McManus (correctly) recalled "was a good time to be a buyer of stocks," if one avoided tech and telecom, as well as mega-cap names in general.

Furthermore, he noted 10-year Treasury yields were much higher three years ago -- by about 225 basis points -- adding to the relative attractiveness of current equity valuations.

As for the war, "rapid progress in the military operation to oust Saddam Hussein ... is likely to stoke the global economy by boosting consumer confidence," the strategist wrote, adding a nod to the salutary effects of falling energy prices.

Naturally, skeptics are (

ahem

) skeptical about all these optimistic assumptions.

Fundamentals Say "Bah Humbug"

"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," Stephen Roach, chief global economist at Morgan Stanley, argued late last week.

The U.S. economy has "slowed to stall speed" and is thus vulnerable to shock, while corporations are "awash in excess supply and lacking in pricing power," Roach commented. This puts the onus of recovery "back on the back of the tired and overextended American consumer" at a time of weakening labor markets.

Such fundamental concerns leave Roach "decidedly on the bearish side of the cyclical call for the U.S. economy." Furthermore, he's "equally concerned over the secular call" owing to "persistent postbubble excesses, deflationary risks, anemic national saving, exploding budget deficits and massive current account gaps."

Jeffrey Saut, chief equity strategist at Raymond James, reached a similar conclusion. "Clearly this is

not 1991 redux, despite

some participants' hopes, no need, for it to be," Saut commented. He cited the absence of (domestic) terror threats in 1991, higher interest rates back then (with the potential to fall), weaker auto and home sales (with the potential to rebound and boost economic growth), lower equity valuations and much higher mutual fund cash balances (12% vs. around 5% currently).

"We don't understand how anyone can expect a

price-to-earnings multiple expansion in the type of muted economic/earnings environment we envision, which is what is necessary to drive stock prices higher," he concluded. "That is why we continue to think the markets will remain range-bound at best." (Of course, those betting on P/E expansion don't believe the recovery will be "muted.")

Saut isn't dogmatic, noting recent "momentum moves" such as last week's retreat for a few days before resuming and extending. He believes the

Dow Jones Industrial Average

could approach 8700 near-term before topping, while others are eyeing the post-October highs of around Dow 9000, 954 for the

S&P 500

and 1521 for the

Nasdaq Composite

as likely stopping points.

While not dismissing the potential for further near-term upside, Saut remains long-term defensive on shares, based partially on Dow Theory, which flashed a bearish signal in late 1999.

Reflecting that signal, Richard Russell, editor of

Dow Theory Letters

, has been and remains quite bearish -- regardless of developments in Iraq.

"What I believe we're seeing now is the

beginning

of a watershed change in people's attitudes toward stocks," Russell wrote in his latest letter. "People are not ready to totally dismiss stocks, but they are on the way. Before this bear market has breathed its last

breath, I expect people and former investors to be totally disgusted with stocks -- that stocks are for 'suckers and morons.'"

I added the italics because a lot of folks think we're already at that stage. But mutual funds, 401(k)s, IRAs and other measures of household ownership of stocks suggest otherwise, as does media coverage of "the market."

Russell believes a break of the Dow's October (closing) low of around 7286 will trigger the "second phase" of the bear market. It is during this phase where stocks (and investors) "discount deteriorating conditions in the economic, social and political fabric of the nation," he wrote.

Parting Short

Some may say:

So bulls are bullish and bears are bearish? So what?

The point is that with the market retreating in (thus far) orderly fashion at the first sign of "trouble" in Iraq, now's the time for market participants to contemplate their assumptions.

Bulls must ask themselves if things really have changed so dramatically for the better just because war is under way. If Baghdad falls

tonight

and in relatively "easy" fashion, will that obviate issues such as the cost of rebuilding Iraq or rising anti-American sentiment and accompanying terror threats? Or that New York Fed president William McDonough was correct when he said last week: "The business sector continues to be restrained not just by geopolitical uncertainty?"

Bears, conversely, must consider what has (and can still) go "right" with the war and, potentially, the economy and world politics. Or that even if long-term skepticism is justified (still my view, for those who are curious) that stocks can rally further in the short to intermediate term than fundamentals may indicate is justified.

I don't know if the gurus mentioned above have done that internal processing, or have merely reached conclusions that support preconceived notions. All I'm saying is: Avoid that trap.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.