By Kenneth Barry
NEW YORK (Reuters) - Killing Saddam Hussein (news - web sites)'s sons this week gave a temporary lift to stock prices, but investors will need more evidence that Iraq (news - web sites) is stabilizing before the market can expect more sustainable gains.
Capturing or killing Saddam himself could give stocks a big boost, but even that wouldn't guarantee peace in Iraq, analysts said, and put investors at ease.
"If we don't make economic improvements, if we don't install a stable government ... that can rule the Iraqi people with Iraqis, then I see this becoming much larger and more influential for the markets," Ned Riley, chief market strategist at State Street Global Advisors, said.
The biggest danger is that U.S. forces might get trapped in a quagmire, losing more and more lives to fierce skirmishes with pro-Saddam guerrilla forces. That could indirectly raise U.S. business costs and hurt corporate profits.
Fighting such a war would drive the rapidly growing U.S. budget deficit even higher, putting upward pressure on U.S. interest rates. It would also slow reconstruction in Iraq and reduce the chances of getting Iraqi oil production flowing freely, key to any early drop in oil prices.
In the market's view, progress in calming postwar Iraq could ease the strain on the U.S. Treasury -- with the federal deficit now expected to hit a record $450 billion this fiscal year. It also would help reduce oil prices and in turn raw material costs for American companies.
To be sure, the deaths of Saddam's two sons in a gun battle with U.S. forces was seen as a step toward the U.S. government's goal of pacifying and reconstructing Iraq.
CALMING POSTWAR IRAQ
But a number of nagging concerns persist. World oil prices remain stubbornly high and Iraqi production remains stalled. The ultimate price Uncle Sam will pay for a protracted U.S. military presence in Iraq is unknown. And the toll of U.S. and British soldiers killed rises almost daily -- months after the most intense phase of the conflict ended.
Against that backdrop, the Bush administration has been put on notice that time may be running out.
A panel of five independent policy experts last week told the Defense Department the window of opportunity is closing rapidly. If growing anti-Americanism is not quelled soon and order restored, Iraq will remain plagued by lawlessness, unemployment and unreliable basic services.
"The next three months are crucial to turning around the security situation" in Iraq, the experts said in a report.
For months before the war, stock prices sagged and investors fretted about the outcome. The markets hung on almost every headline.
And when the war came, it was executed with a speed and effectiveness that exceeded expectations, said Fadel Gheit, senior energy analyst at Fahnestock & Co. Inc. But "the peace so far has failed on all scores," he said.
CLEANING UP MESS
Basic services for Iraqis are nonexistent, Gheit said. The capital doesn't have reliable electricity or proper sewage. The goodwill Iraqis may have felt toward the U.S.-led forces for deposing Saddam is being squandered. The loss of more American GIs could undermine public faith in Bush's policies.
"Cleaning up the mess in Iraq will be pivotal, not just for the stock market, but for confidence in the White House," Gheit said.
U.S. officials hope the elimination of Saddam's sons will help stop the guerrilla fighting, but so far there is no evidence that casualties among U.S. and British forces will decline any time son. Finding Saddam himself would remove the biggest factor feeding anti-American resistance.
"It would symbolize the complete collapse of the old regime," said Jim Glassman, a senior U.S. economist with J.P. Morgan Chase & Co.
It also could lift the Dow Jones industrial average by 200 points, said Louis Navellier, who manages $5 billion for Navellier & Associates, said.
Recent comments by Deputy Defense Secretary Paul Wolfowitz were helpful for investors because they helped reduce possible uncertainty about U.S. intentions, Navellier said. "It's clear we are going to stay there until the job is done," he said.
AVOIDING QUAGMIRE
But such determination may carry red flags for investors, too.
The United States is spending about $5 billion a month to support operations in Iraq and Afghanistan (news - web sites). The fear is that the United States will bog down in Iraq, draining federal coffers and causing a flood of red ink.
A return to huge federal deficits translates into more government borrowing and rising interest rates -- anathema to the stock market because of the drag on corporate profits.
The delay in restoring Iraq's oil production is keeping world oil prices artificially high and hindering U.S. economic recovery, Tim Evans, senior energy analyst at IFR Pegasus, said. "If oil prices were closer to $25 a barrel, we might see an extra half percent or 1 percent growth added to GDP (news - web sites)," Evans said.
The United States will probably have to stay in Iraq for at least three years and maybe four, Evans said.
"Financial markets can live with that, but we'd be a little happier if the U.S. is able to share the load, and the key is getting the U.N. involved," he said. (Additional reporting by Chris Sanders)