April 13, 2004

Falluja is a Sell Signal--Even Though the U.S. Will Win

Dear Reader, First, my apologies for the irregular blogging schedule in the last two weeks. Sometimes you have to do a little less writing and a little more reading and thinking if you’re going to have anything worth saying. Today, I’ll get back on track. However, I do want to let you know that next week I’ll be travelling to Dallas for an Options Conference so there may be some small interruption there too. But for now, let’s move on. Before I do any market blogging (bad day for metals stocks, good day for put holders on metals stocks) I want to share with you a small piece of analysis I produced in response to a question by Bill Bonner and the editors of the London financial publication MoneyWeek. The questions was, “Is what’s going on in Iraq at all like the Tet offensive in 1968? And what was the effect of Tet on markets?” The unasked question was, what effect will Iraq have on markets as we head into spring? The short answer: Tet was a sell signal. Here’s the long answer. Tet began late on the night of January 30, 1968. It was the beginning of Tet Nguyen Dan, or the lunar new year’s day. It was a series of forty major attacks and dozens of other minor attacks all over the south by the North Vietnamese Army (NVA) and the Viet Cong (VC). Militarily, Tet was a disaster for the NVA. Military historian Victor Davis Hanson estimates the kill ratio for U.S. forces was over 50-1. The NVA were beaten back nearly everywhere they attacked. But even the fact that attacked everywhere caused political shockwaves in America. Nineteen sixty-eight was an election year. The offensive took place only two months before the New Hampshire primary. In South Vietnam it appeared to catch the Americans and the South Vietnamese by surprise. Tet had been a traditional truce day in the war. And in fact, the NVA made a point of saying in public it would observe a seven day cease-fire beginning on the 31st—a promise it fully intended on breaking. The NVA was looking for some kind of tactical surprise to compensate for its lack of firepower. It got the surprise it wanted. But the campaign—in military terms—failed anyway. Yet it’s strategic success was astounding. Why? The biggest problem was that the American public had been led to believe the war was going well and victory was in sight. And in that sense, the strategy behind the attacks was brilliant. It didn’t aim at American military might, but American public opinion—by far the weakest element of the American campaign. Americans didn’t trust their political leaders, even less so when they saw images of a country seemly on the verge of chaos and anarchy after they’d been told everything was fine. It was a well aimed psychological blow at the morale of the American people. The campaign by NVA general Vo Nguyen Giap was a textbook example of using shock and awe to undermine public support for the war through media images. What the NVA couldn’t accomplish militarily it did through other means—achieving the same goal in the end. The offensive was a tactical disaster. But strategically, it led directly to the U.S. pulling out of Vietnam. The power of the media to shape public opinion by choosing how to report a story was firmly established. We’re seeing the same thing today. But are Western media accounts of Iraq accurate? Maybe, maybe not, although today’s reporters find it a lot harder to misrepresent the truth than they did back in 1968. For example, during the Tet offensive, the NVA was helped tremendously by what may be one of the most infamous instances of lying in the history of journalism. Then-AP correspondent Peter Arnett gave America a phrase that made the logic of the war seem barbaric. Perhaps war is always barbaric and illogical, but Arnett simply made up a story up that changed the course of public opinion. You’ve probably hear the phrase, “It became necessary to destroy the village in order to save it.” Peter Arnett put that quote in a story and attributed it to an unnamed American officer. The quote ran in a February 7th story describing a battle at Ben Tre. It made it sound like the Americans had gone completely insane, flattening villagers to save them from themselves. Ben Tre WAS destroyed, but not by Americans. It was destroyed by the retreating Viet Cong. And it’s doubtful that any American officer ever said anything of the sort to Arnett. The closest you’ll find is an American officer who recalls telling Arnett, “It was a shame the village was destroyed.” The American war effort was also destroyed, at least psychologically. As Sun Tzu and Liddell Hart have both said, you defeat your enemy by collapsing his will to resist. The will of the American population to fight in Vietnam was effectively destroyed. Just a month after Arnett’s dispatch from Vietnam, Eugene McCarthy humiliated Johnson by polling at 42% of the vote in the Democratic primary compared to 49% (less than a majority) for the sitting President of the United States. Johnson couldn’t even carry a majority of his own party in a primary, and by April, he’d abandoned the race altogether. During the first six days of Tet, the S&P 500 showed little reaction, going from 92.90 on the 30th to 91.90 on the sixth. But in the first three trading days AFTER Arnett’s AP story was published, the S&P fell 3.2%. The psychological worm had turned. By the fifth of March it had fallen to 87.70. It wasn’t until Johnson officially left the race on March 31st the index appeared to take off. It was a sucker’s rally, though. Between March 31st and December second, the S&P tacked on a 16.7% gain to close at 108. However, by May of 1970, it would shed 36%. In fact, the S&P wouldn’t trade near 108 again until March of 1972. And by then, it was on its way to making a blow off-top at 120. Another sucker’s rally. What came next was the hideous bear market of 1973-1974. The S&P lost nearly 50% before settling in at 62. It wouldn’t close above 120 again until July of 1980—six years later. Tet was a sell signal, even though in military terms, it was a victory. It’s a testament to the psychological fragility of investor. But then again, maybe people felt bearish already…bearish on Johnson, bearish on Vietnam…and when they came to their senses…bearish on stocks. Maybe Tet was just the emotional reason investors used to sell. In that respect, today’s situation in Iraq bears looking at. The market is overbought. The economy gives conflicting signs of its fundamental health. America finds itself in the midst of another contentious election and another contentious war. Is Falluja a sell signal? The military reality and investor perception may be entirely at odds. That is, the U.S. may come out of this situation better of militarily. But investors may still use it as an excuse to sell, no matter what ends up happening in Iraq. Militarily, it’s impossible for me to say what’s really going on on the ground. But my suspicion is that the so-called uprising in Iraq is probably going to be even less successful than the NVA’s calculated military gamble. Why? There’s no Ho Chi Minh trail in Iraq. True, there are Syrian and Iranian element of support for Shiites in Iraq. But these Iraqis aren’t well supplied to win a long fight with the U.S. Second, there’s no global superpower behind the events in Iraq—making it much harder for whoever’s fighting the U.S.—Sunnis OR Shias—to outlast the Marines and the Army. Third, even a hostile media is going to have a much harder time distorting what’s actually going on in the country. You don’t have to hop on a plane and see for yourself of even be an expert to realize that many Iraqis have no respect for the people fighting the Americans. This doesn’t mean Iraqis LIKE Americans necessarily, or the occupation. But it does mean, if you take Iraqi bloggers at their word, there is a lot less support for a “civil war” than you’d guess from reading Western newspapers. The real target in this uprising is the U.S. voter. Show him images of dead Americans being mutilated and you can drive the Americans out of the country, or at least Bush out of office. That is the strategic goal in Iraq. Undermine the morale of America. It could work. But even if it doesn’t, it’s a sell signal for investors. Pre-Falluja highs on the S&P (for this rally) are at about 1,155. The most recent attempt to break through that was on April 5, when the S&P closed at 1,150. But even there, the S&P is still 20 points below its initial bear-market rally of 1,170—a level it last reached in March of 2002. Your best investment decision? Sell stocks because they're pricey and America’s coming off an enormous credit binge. You don’t need any other reasons. And if other investor’s want to wait until some other event triggers their selling instinct, that’s their affair. No use panicking later when you can sell now and avoid the rush.


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