- The Washington Times - Monday, May 17, 2004

Stock indexes plunged to their lowest levels of the year yesterday after the head of Iraq’s governing council was killed by a car bomb, culminating a series of events unraveling in Iraq that, along with record high oil prices and rising interest rates, have raised fears on Wall Street.

The Dow Jones Industrial Average fell as much as 150 points before recovering some on bargain hunting to end down 106 at 9,907, its lowest close since December. The Standard & Poor’s 500 Index fell 11.60 to 1,084, also a low since December. The Nasdaq Composite Index lost 1.5 percent to close at 1,877, its lowest since October. Indexes elsewhere in the world also were down sharply on the unrest and rising oil prices.

The latest suicide bombing in Iraq sent oil prices surging to a record $41.55 a barrel in New York trading. Several attacks in Iraq this year have targeted the nation’s oil facilities and disrupted attempts to bring Iraq’s vast oil reserves back into the world market.

“U.S. stocks are not in good shape, despite the booming economy and blowout earnings numbers. Iraq plays a big role in this,” said Lawrence Kudlow, founder of Kudlow & Co. He notes that the constant stream of images coming out of Iraq, from battlefields to prison abuses, is taking a psychological toll.

“Investors see things in Iraq that shouldn’t be happening and they fret.” They not only are worried about economic damage from feverish oil prices prompted in part by the attacks on oil infrastructure. They also fret about the possibility of terrorist attacks in the heat of the presidential election season, perhaps during the political conventions this summer, he said.

Joseph P. Quinlan, chief market strategist with Banc of America Capital Management, said the markets are reacting sharply to the spreading insurgency in Iraq because investors had largely come to the conclusion last year that the U.S. venture would be short and successful, like the war was itself.

“Winning the peace is proving a great deal more difficult than winning the war,” he said. Since last month, the highest number of Americans have been killed in a single period since the war, troop reductions have been put on hold, the administration has sought $25 billion more for Iraq operations, and public opinion has turned against the occupation, he noted.

“The ‘Iraq effect’ has emerged as a significant drag on U.S. indices, along with the threat of rising interest rates,” he said. The insurgency and terrorist attacks in Iraq have slowed efforts at reconstruction and democratization, he said.

And rather than recede, as investors hoped last year, the violence and “acts of terrorism have spread to other nations, including Turkey, Spain and Saudi Arabia,” helping to drive up oil prices, he said.

With public support for the occupation eroding, President Bush’s re-election prospects are diminished, a negative for Wall Street, Mr. Quinlan said, because it means his pro-investment tax cuts and other strong market-oriented policies may not be extended.

Because of the large political ramifications, the market’s worries about Iraq are likely to last longer than concerns about rising interest rates, which should dissipate after the Federal Reserve takes action in the coming months, he said.

Interest rates and record oil prices already have wiped out the market’s gains for the year, and Marty Chenard of StockTiming.com said the worst may be yet to come.

That is because of the influence large and secretive hedge funds are wielding in the markets, he said. During the period in which the Fed held interest rates at 40-year lows, hedge funds borrowed heavily to make leveraged investments in stocks and bonds, and they now are being forced to unwind those positions — contributing to recent losses in stocks and bonds.

“In a move to find safer ground, hedge funds are now … making bets that the market will drop,” he said. “One hedge fund recently bought 120,000 Nasdaq put contracts, which is a huge bet that the market will go down.”

Unless other equally large institutional investors, such as pension and mutual funds, get off the sidelines and come to the market’s rescue, the bets hedge funds are making against the market are likely to become self-fulfilling in the weeks ahead, he said.

“The irony,” he said, “is that this could be a replay of what caused President Bush’s father to lose his last election.”

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