Markets won't recover until shooting starts

`Ultimately, investors have no more insight into how the war might go than the average Joe in the street. The market has no mechanism for measuring the different options, or for deciding which outcome is the most likely.'

The bear market turned out to have another leg after all.

Following brief, nervous rally of the summer, global share prices have taken another step down. The US market is grim, European markets dreadful.

Germany's DAX index is down 39 percent this year, France's CAC 40 is off 34 percent, and Britain's FTSE has fallen by 25 percent. Overall, the Bloomberg European 500 index is down 28 percent.

Nobody to search for reasons to be gloomy. Bear signals drop from the trees like low-hanging fruit.

In Germany, a government that made virtually no progress on economic reform in its first term has just been re-elected with a wafer-thin majority and increased power for its Green Party allies. Even the weak reforming impetus of Chancellor Gerhard Schroeder's first term is likely to fade.

In France, consumer spending has started falling, as unemployment rises, killing any hopes that its new government is going to engineer a rapid recovery.

In the Netherlands, consumer confidence has just fallen to its lowest level since records began in 1986, and the Dutch economy is expected to grow at only 0.5 percent this year, the lowest rate in 15 years.

The European Central Bank looks to be refusing to contemplate lower interest rates, even as Europe's slips closer to recession. Otmar Issing, the ECB's chief economist, said this week he believed rates were "appropriate," while Vice President Lucas Papademos said there was no pressure to cut. What he might regard as "pressure," he didn't say.

Those are all perfectly good reasons for selling equities.

But the big, dark cloud hanging over the markets is Iraq.

Until is clear whether there will be a war, and until it is clear how quickly and cleanly that war will be won, there is little prospect of any recovery in equities.

Until the shooting starts, the markets will remain depressed.

A war with Iraq would have a huge impact on the global economy -- the issue for the markets is how to price that.

How much is the war likely to cost? Nobody quite knows.

Lawrence Lindsey, economic adviser to US President George W. Bush, has said it could cost as much as US$200 billion. That figure has been disputed by the White House.

The truth is any figure from US$20 billion to US$200 billion is plausible. Even when the cost is known, how will it be paid for? Will US taxes rise, or will the government borrow more? Again, no one knows.

The impact on the oil price is just as imponderable. A liberated pro-Western Iraq would pump oil furiously, maybe sparking a savage price war between OPEC and Russia. Oil at US$10 a barrel for a generation? Maybe.

A longer, nastier war could restrict supplies out of the Middle East, possibly permanently. Oil at US$45 a barrel for a generation? Maybe.

The impact on business and consumer confidence is no more certain. After a quick victory, confidence would soar, and the re-construction of Iraq would begin. A longer war would pose the issue of tax rises, and it could devastate the travel and tourism industries.

Now try to figure out what all that means for the next five years of earnings at Volkswagen AG or HSBC Group Plc.

It's hardly surprising that people are giving up.

Pricing events is what the stock markets does, and usually it is good at it. Corporate earnings, industry trends, changes in interest rates, and changes of government, are all events the stock market can take in its stride. It can weigh the odds and come up with a price.

A war is different. The markets can look back to the Gulf War a decade ago, and draw some lessons. Ultimately, investors have no more insight into how the war might go than the average Joe in the street. The market has no mechanism for measuring the different options, or for deciding which outcome is the most likely.

In those circumstances, the most rational response is to sit on your hands and do nothing -- and, when the occasion presents itself, sell a bit more of your portfolio. The market's current judgement -- roughly translated as "we don't have a clue what's happening" -- is just about right.