Bush's stock was rising when Dean looked to be the nominee, but has settled back now that Kerry is the opponent.  It will be interesting to see who the Democratic Vice Presidential nominee is.  Edwards is the popular nod, but that would  combine two senators, whereas a Southern or Western governor or business executive would broaden the appeal of the ticket.

As we recall from the 2000 election, it's not the popular vote but the electoral vote that counts.  Certain states, like New York and California, are clearly going Democratic, while states like Texas and Virginia, are clearly going Republican.  Most of the campaign will be fought, therefore in states that could go either way, including Florida, of course, but also Iowa, Michigan, Minnesota, Pennsylvania, and Wisconsin.  It will be a long, partisan, emotion driven as opposed to issue driven, dispiriting campaign. 

US stock markets sagged when Kerry romped through Super Tuesday last week and probably won't make much headway until the conclusion becomes apparent.  The Wall Street analysis, ignoring social issues, is that the deficit producing, regulation cutting, war-pursuing Republicans are preferable to the tax-raising, regulation increasing, multi-lateralist oriented Democrats.

War on Terror

In every conversation of the last six months, we've reminded our clients that achieving a terrorist attack in the United States between now and the election remains a top priority of Al Qaeda.  There are a couple of reasons to think this risk is diminishing.  The wrap up of Gulf War II in Iraq allows the US military to divert resources, notably Special Ops teams, surveillance resources such as Predators and Blackbirds, and bandwidth back to the Afghanistan/Pakistan border where Bin Laden and second-in-command Al-Zawahiri appear to be hiding out. 

The second reason, is that, while Al Qaeda has launched several terrorist attacks in the 2 1/2 years since 9/11, with greater frequency these attacks are occurring on Arab soil and the primary casualties are Muslims.   In the most recent example, 170 Shiite Muslims were killed by suicide bombers and rockets in Baghdad, Iraq, another 32 Shiite Muslims died that day under similar circumstances in Quetta, Pakistan.  The motive, apparently, was an attempt by Al Qaeda operatives to foment civil war between Shia and Sunni Muslims (after Israelis and Americans, Shia Muslims are considered the biggest threat to mainstream Sunnis.)   Few Arabs shed tears when the World Trade Center and Pentagon were attacked in 2001 (indeed, 90% of Arabs believe that the American CIA launched the attacks) but these recent attacks on Muslims, the Saudi Arabian family and President Musharraf of Pakistan are motivating quite a clampdown on Al Qaeda activities and financing. 

However, 190 commuters were killed this morning by multiple bombs on commuter trains around Madrid, Spain.  The initial analysis was that ETA Basque separatists had launched the attack.  However, an Al Qaeda affiliate claimed responsibility later in the day; if so, this would be the first Al Qaeda attack outside the Muslim world since 9/11.  The attack has characteristics of Al Qaeda in that multiple explosions were detonated (10 bombs, with three other found and disarmed).  The largest scale ETA attack killed 21 people in a single blast at a Barcelona supermarket in 1987.  Also, the ETA usually phones in a bomb threat; no such warnings was received today.  So Al Qaeda may be down, but by no means out.

Even if Bin Laden and the remainder of Al Qaeda leadership are captured or killed, it would solve only 1% of the problem between the Arab world and the West.  Countries of the Middle East are under enormous stress as high birth rates and economic stagnation have caused living standards to fall by half over the last 30 years.  Unemployment rates average 15% in the region, up to 30% in places.  Saudi Arabia, which sits on the world's largest proven reserves of oil, is none the less an economic basket case.  Debts to the West are rising, per capita GDP is falling (by over half since 1980), the royal family, estimated at 5,000-10,000 males, takes the lion's share of oil sales, religious extremism is rife, free press is non-existent, and recent tiny steps towards democratic representation can be reversed at the whim of the royal family.  Iran, 25 years after the fall of the Shah, stagnates under a theocracy of Imans every bit as oppressive as the secular government it replaced.  Pakistan, which we flagged some time ago as one of the most dangerous countries in the world, squanders billions of dollars in pursuit of nuclear weapons and the missiles to deliver them, even though basic roads, hospitals and school go unbuilt.

The United States' overthrow of Hussein, rather than filling Arab, particularly Iraqi, hearts with joy, only emphasized the impotence that most Arabs feel about their fate.  Hussein, after all was promoted by the Americans in the 1970's and initially supported by the Americans in his eight year war with Iran.  However, when he outlived his usefulness (according to the Arab interpretation) he was disposed of like an old dog.  Arabs remain obsessed with Israel, not only Israel's conflict with the Palestinians but with Israel's three time defeat of numerically superior armies of Egypt and Syria.  Israel's construction of a fence against terrorist infiltration is an affront, even though similar fences already exist between Saudi Arabia and Yemen, and along the line of control separating Pakistan controlled Kashmir from India controlled Kashmir.  The recent American proposed "Middle East Initiative," therefore, which proposes good governance (i.e. legitimate elections), education, economic growth and basic civil rights for women, is widely rejected as yet another attempt by the Americans to impose their will on the region.

The situation in Iraq has stabilized to the benefit of the United States.  Coalition forces killed fell from 83 in the month of November, to 38 in December, to just 5 in the last 4 weeks.  As coalition forces draw back from day to day policing of the cities, as coalition forces become more adept at anticipating attacks, avoiding mines and capturing resistance cells, and as Iraqis take more responsibility for their government (a constitution was signed earlier this week, with general elections promised by year end), the opportunities for armed opposition are greatly reduced.  Also, as we commented some time ago, capturing Iraq would allow intelligence operatives great opportunity to discover terrorist networks, arms sales in the region and the network of suppliers who were accommodating Iraq through illegal oil sales.  This intelligence produced the discovery of nuclear and chemical weapons sales to Libya, which has not only agreed to give up these programs but has also fingered its suppliers among Europeans and most importantly the Pakistanis, which in turn has produced additional intelligence about nuclear weapons programs in Iran and allows the US to apply sanctions against the Syrians to turn over their weapons programs.  Lastly the United States, in return for not embarrassing Pakistan about its proliferation of nuclear secrets, has forced Pakistan's agreement to help hunt down Bin Laden (although frankly it might be more important to grill Abdul Qader Khan, the chief proliferator, about his dealings with, for example, North Korea.)  We also commented pre-war that it would be interesting to find out who was helping Iraq evade UN sanctions.  A document accounting for kickbacks in the oil voucher program documented 270 beneficiaries, including Russian, German and French suppliers, Palestinian terrorist organizations, and various political figures including a British member of Parliament, who apparently benefited to the tune of $9.5 million for his steadfast opposition of the invasion.

So even though the invasion of Iraq has yet to be justified by WMD discoveries, the overthrow of its ruler and the imposition of a friendlier government has yielded substantial security benefits to the United States.  And, as we noted before, there's no evidence that US troops will be withdrawing anytime soon, they'll simply pull back to secure bases scattered around the country.

 Strategy

We're sticking to our forecast of 8-10% gains for the S&P 500 in 2004. We were a little concerned when the S&P 500 rallied 4.1%, the NASDAQ 7.5% in the first 6 weeks of the year (too far, too fast.)  Now that the averages have settled back near start-of-year levels, we're investing cash in equities once again.

The Heron Capital Management client letter is published immediately following quarter end and 1 or 2 additional times per quarter. The views expressed in this letter represent HCMI opinion and strategy as of the date published and can change at any time upon receipt of new information. Data quoted in this letter are from sources deemed reliable, but no guarantee of such data is implied.