President Bush tried to drum up support for his $670 billion tax-cut plan this week and Democrats offered a new alternative, but by Friday the domestic agenda had virtually disappeared into a swamp of war fears.
STOCK PRICES FELL SHARPLY Friday to their lowest close since Oct. 16 as Wall Street looked nervously ahead to next week’s report on Iraq from U.N. weapons inspectors and Bush’s State of the Union address. The Federal Reserve also holds a big two-day meeting next week, and there are rumblings of a possible shift in policy. But the central bank seems almost an afterthought to the question of whether the United States will launch a war.
“There are so many different rumors swirling around about Iraq, it clearly shows where the market’s mind is,” said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co.
The Dow Jones industrial average fell 238.46 points to close at 8,131.01, although that was still 12 percent above its close on Oct. 9, which so far marks the bottom of the three-year bear market. For the holiday-shortened week, the benchmark index lost 5.5 percent, its worst performance since July. The Nasdaq composite index, composed largely of technology stocks, lost 46.14 points or 3.3 percent for the day to close at 1,342.13.
“Nobody wants to put money up over the weekend — you never know what could happen with the international situation,” said Jim Volk, managing director of equity trading at D.A. Davidson & Co. “There is no catalyst for equity buying at this point.”
As geopolitical concerns towered over the domestic agenda, Bush tried to keep at least one light focused on his economic plan, inviting 15 prominent economists to the White House to pitch the tax-cut proposal and hear their reactions.
With the 15 economists in the Roosevelt Room, “there was not complete agreement on every single point,” said Brian Wesbury, one of the participants.
“There were some economists there who thought we needed more stimulus than the president has proposed,” said Wesbury, chief economist for Griffin, Kubik, Stephens & Thompson, a Chicago-based brokerage. “But there was a general consensus that this was a good plan. I came out of this fully aware that the president is energized behind this plan. He is willing to spend political capital pushing it through, and he believes it helps the economy not only this year but over a long period of time.”
But politically, Bush’s plan to eliminate the tax on dividends and accelerate income tax rate cuts could be held hostage to the outcome of the situation in Iraq, said Don Straszheim of Straszheim Global Advisors.
If the war goes well, and a new regime takes charge in Iraq, Congress’ attention will turn quickly to the tax bill and Bush’s hand will be enormously strengthened, said Straszheim. Bush could fare equally well even without a war if Iraqi leader Saddam Hussein could be persuaded to step down voluntarily and go into exile.
“The other side of the coin is if the war doesn’t go well — if we’ve blown Baghdad to pieces and nobody knows where Saddam is,” Straszheim said. “Then I think it is a very different scenario.”
Democrats, he said, would be emboldened to “resist the president’s tax changes from top to bottom.” And stock prices could tank as Wall Street adjusts to the likelihood of a one-time injection of fiscal stimulus rather than long-term tax relief.
“Wall Street loves this president,” Straszheim said. “Wall Street already has got him re-elected. Everyone would be rethinking that quickly. Instead of marking their forecast up they would be marking their forecast down because the tax bill is going to be a more temporary giveaway without any structural benefit.”
A third possibility, hinted at Friday in some news accounts, is that the Bush administration will give the U.N. inspection process more time, delaying any war or resolution to the tension. That would be “slow torture” for the stock market, Straszheim said, and for corporate executives who have been delaying decisions on investment and hiring.
Already Wall Street has reason to be nervous about Bush’s prospects. Recent polls, including one done for NBC News and the Wall Street Journal this week, show Bush’s popularity has eroded sharply over the past two months because of both domestic and foreign policy issues.
Meanwhile the Fed largely has been relegated to the sidelines since its aggressive half-percentage-point rate cut in November, although there is speculation central bankers will shift their formal policy stance in preparation for one more rate cut within the next several months. But most analysts believe Fed policy-makers will reiterate their view that economic and inflationary risks are “balanced.”
“I think they believe there are temporary developments that have a good chance of disappearing or at least subsiding in the coming weeks or month,” said Dick Berner, chief U.S. economist for Morgan Stanley, referring to the Iraqi situation and the recent spike in energy prices.
He estimated that there is a one-in-three chance the Fed will cut short-term rates by another quarter-point at its next meeting March 18.
By then the Fed is likely to have more evidence of economic weakness. The government next week will give its initial assessment of the economy’s overall production in the fourth quarter, and analysts on average expect the report will show negligible growth of 0.7 percent, which would be the slowest since the third quarter of 2001, when economic output actually shrank.
There have been occasional signs that the stumbling economy may be regaining its footing, including this week’s report that the index of leading indicators edged ahead for a third straight month. But the coincident index, a snapshot of the economy’s current condition, remained unchanged for a third straight month.
“We still have a troubled economy,” said Patrick Kelly, managing director at LaSalle Bank’s broker-dealer services division. “The labor market is continuing to struggle in a very, very real way. Corporate earnings are not getting consistently strong. It looks like an economy that wants to break out but stays mired in the position that it’s in today.”
And the latest batch of mixed economic data has given economists little reason to expect substantially better growth in the current quarter.
“The economy looks quite weak,” said Straszheim. “We’re not in recession, I don’t believe, but the fourth quarter was no good and the first quarter is not going to be any good either.”