A war in Iraq would increase the chance of a double-dip recession in the US and across Europe
An 'inevitable' war. Not exactly the sort of thing to cheer the markets after the summer break, when a brief rally in US markets held out hope that a double-dip recession could be avoided. But now, in addition to the global economic downturn, the prospect of a war is all too real.
Tension has been building all year over the US-led agenda on the Middle East. At one point, with corporate disasters dominating the headlines, it appeared as if George Bush had been persuaded to focus on domestic issues. But there can be little doubt that following the anniversary of the 11 September bombings, the US will ready for military action.
Investors probably have a few weeks to position themselves for the coming winter. There are few secure or comfortable shelters. Economic data from the US is ever more gloomy. According to the Brookings Institute in Washington, recent US corporate scandals are set to cost the economy some $35bn, about the same as a $10/barrel rise in the price of oil, or between 1% and 2.5% off economic growth in the next 10 years. The service sector in the US accounts for 80% of jobs but latest data shows growth is nearly at a standstill. Corporate earnings have long been on the slide but now consumer confidence and spending, which have been supporting the markets through the year, are weakening.
With the Sarbarnes-Oxley bill becoming law, the US administration may feel it has dealt with the economic challenge at home. But mid-term elections are just around the corner, and a key electoral pledge has been fiscal easing. If tax revenue has dropped sharply because of falling corporate profitability, tax cuts are not likely to be on offer.
Earlier on this year, as the euro single currency strengthened against a softer dollar, investors hoped that the Eurozone economy would pick up where the US had faded. But in both France and Germany, growth has been disappointing, as has the pace of structural and corporate reform.
Investment is slowing and budget deficits are widening. France, Germany, Italy and Portugal are struggling to meet the requirements of the Eurozone stability pact, which includes a commitment to keep budget deficits at or below 3% of GDP. Germany faces a general election on 22 September, and Chancellor Gerhard SchrÃ¶der is more preoccupied with local issues, including the clean-up after the recent floods in central Europe, than backing an anti-terrorist alliance against Iraq.
Another area of disappointment is Japan, where the Nikkei 225 hit a 19-year low last week. The budget deficit continues to grow and the banking sector is under increasing pressure as the stock market plunges. There are some attractive possibilities in the rest of Asia, but any good news from these markets, or others like the UK, where the outlook is least depressing, is outweighed by cloudy prospects for the US.
In fact, UK data shows the economy strengthening slightly, but sentiment is so fragile it hardly makes a difference. Historically, September is a month for stock market weakness anyway, and there are just too many reasons to sell. The FTSE 100 is just managing to hold above the 4,000 mark but any rally quickly dissipates. The last refuge for the optimists is to urge investment at these bargain levels. But even that strategy is now vulnerable. By almost any measure, shares in mainstream markets are still not particularly cheap and could have further to fall. By this time next year, investors could be begging for a double-dip recession. At least that suggests a rebound at some point.
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