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Funds Anticipate Quick Resolution in Iraq

A quick and victorious war lasting no more than two or three months is what most mutual fund managers anticipate will take place in Iraq, but if that does not happen, it could spell serious trouble for the markets, which have already factored such a scenario in. Even those enthusiastic about a quick resolution temper their remarks by saying an unimaginable disaster could take place, instead.

After weeks of speculation about the crisis in the Middle East, the so-called clarity of the war's first bombs gave a boost to the markets, which fund economists and managers welcomed, at least in the short term.

In order for the economy to revive and markets to return to normal levels, the Iraqi situation must be resolved, Martin Schulz, director of international equity investments for the Armada Funds of Cleveland, said in market commentary.

Schulz's yearning for a resolution in Iraq echoed the sentiment of the Dow, which rose 741 points in the past six trading days through last Wednesday, initially when it seemed the war might be delayed, and then again as U.S. troops prepared to strike. But the bear market will probably "mute" any rally a victorious war might bring, Schulz added.

Boston-based Putnam Investments Senior Economic Advisor Robert Goodman said there is a 90% chance "the war will be short, we are victorious and they are all waiving American flags in Baghdad." If that happens, the markets will take it as a sign the economy has strengthened, and Bush's 10-year, $760 billion "market-friendly economic agenda" will have a good chance of passing, quite possibly bringing about "a booming economy in 2004," Goodman said.

"Barring catastrophe, it's possible for investor sentiment to shift from the more conservative fixed income and money market sectors toward the equity sector," said Mark E. Mallon, chief investment officer with American Century of Kansas City, Mo.

Scudder Kemper Vice Chairman Robert Froehlich's market commentary was also enthusiastic about a favorable outcome setting the economy back on track, although he hedged his outlook by also pointing to potential worst-case scenarios, namely terrorism in the U.S. or nuclear war in North Korea.

Minneapolis-based First American Funds Chief Investment Officer Mark Jordahl was not so sure a straightforward military conflict would ensure a sound recovery. Even once the geopolitical situation is resolved, that does not ensure business spending or economic recovery will return, Jordahl said. "We will be watching very carefully," he said.

Fund economists have other questions too. Even if the war is resolved quickly, history has proved that while the market gets an initial kick start at the outset of war, it doesn't respond fully until 12 months later, according to an analysis of past military conflicts by T. Rowe Price of Baltimore.

Even Fidelity Investments of Boston posted a CBSMarketWatch news story on its Web site last week indicating that a $150 billion war in Iraq would represent only 1.5% of the $10 trillion U.S. economy.

Hugging the Center Line'

For now, institutional clients of Evergreen Investments of Boston have not changed their holdings significantly. They believe that whatever the outcome of the military conflict, "a move in the market could be big, and they are uncertain which way it will go," explained Gary Craven, managing director of Evergreen's small- and mid-cap growth team. "People are hugging the center line."

Should the war drag on, oil prices would likely remain high, driving up inflation and interest rates, thereby weakening both stocks and GDP growth, according to Alan Levenson, chief economist of T. Rowe. As well, Richard Hoey, chief economist and chief investment strategist for Dreyfus of New York, issued market commentary of his own last week saying that diplomatic rifts caused by the Iraqi tension, continuing problems throughout the Mideast and North Korea, and fragile investor confidence, are also potential monkey wrenches.

Not surprisingly, independent financial analysts offer a more skeptical outlook than fund managers. Mitch Zacks, a financial analyst and vice president with Zacks Investment Research of Chicago, said the possibility of chemical warfare by the Iraqi army or biological or other significant terrorist attack on American soil could prompt the use of nuclear weapons by the U.S. The result, Zacks said, would be a "nightmare scenario for the markets."

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