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June 30, 2004

Market Boom and Bust: War in Iraq, Monetary Policy and Economic Growth

By Kathryn M. Welling

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  • Market Boom and Bust: War in Iraq, Monetary Policy and Economic Growth
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Two distinguished institutional investors weigh up the prospects for the markets in two separate and wide-ranging interviews.

Lee Cooperman, Omega Advisors, New York City

What ails this market?

That's easy. What's going on in the Middle East, terrorism, Iraq etc. But the major issue is whether the economy grows in the second half of the year. In other words, the growth we've had, late last year, this year, isn't a surprise given the very stimulative fiscal policy, the very stimulative monetary policy, the very favorable tax policy on capital gains and dividends. The issue is whether the recent pick-up in employment can be sustained. We have to migrate into a self-sustained business expansion because the stimulus coming out of all the refi activity, the stimulus coming out of falling interest rates, that's going away, because interest rates are going to go up. The question is at what at pace are they going to go up?

What's your answer?

I think everything that fueled the market off the October 2002 lows is reversing. In other words, the market was fueled by falling interest rates, falling inflation and an extremely favorable fiscal policy and I would guess that every one of those variables has reversed direction. The Fed has already put you on notice that they're going to be raising rates. There is no question inflation has bottomed. Look at the world around you, the oil price, the price of natural gas, housing prices, etc. And post-election, we're going to have to deal with the fiscal problem. There wasn't one Democratic candidate who didn't advocate a reversal of Bush's tax policy and I've got to believe with the deficit as large as it is, even Bush, after his re-election, is going to have to deal with it. And since those are the kinds of things the market is worried about here, this correction could take some time. But look at the bright side.

Which is?

On the good side, the market has had a good contraction in its price/earnings ratio and the standard estimate on S&P 500 earnings this year is around $64 for next year. Some people are thinking more like $70-$72 and when inflation's been running 2-3 percent, the multiple on the market normally runs about 16, 17 - which is where the market is. The only way the market gets real exposure to the downside is if something blows up in Iraq or there is a serious terrorist incident. That never used to be part of the lexicon of things that we would worry about, but what can we do? In that case, all bets are off. But ex that, I'd say we're in a trading range I define between low end 10000 and high end maybe 12000; that's not necessarily imaginative, controversial or exciting. But I happen to personally think that if I'm wrong, it's going to be worse and not better.