In the stock market, the first quarter started much the same as it ended — with a star-spangled stock market rally that fizzled. The question weighing on corporate executives’ and investors’ minds after these disappointments was whether a successful resolution to the Iraq war will release a raging bull market.

When war became an inevitability March 11, the Dow Jones industrials began a 10-day, 13.3 percent run. Then the reality of war set in and reintroduced the stock market to its yearlong nemesis — uncertainty.

Major markets closed down for the quarter, with the Dow off 4.2 percent and the S&P 500 down 3.6 percent. The Nasdaq was the only bright spot for investors; it managed to close with a teeny gain of 0.4 percent.

War’s uncertainty

A drawn-out war in Iraq, most experts say, could bring an increasingly sluggish economy to a screeching halt. And though the markets seem to be swinging upwards on any news hinting the conflict might end quickly, they’ve swiftly reversed direction on any hint of trouble.

The last data figure released for the quarter that ended Monday indicated manufacturing activity contracted in February.

“If the war goes on for a couple of months, I think we’ll end up in the midst of a full-blown recession,” said Mark Zandi, chief economist at Economy.com.

He noted he had seen more cutbacks in business hiring and spending.

What may be even more troublesome are signs that consumer activity — what has been the primary offset to anemic business spending — also may be stumbling.

Not counting subprime mortgages, delinquencies ticked up in the fourth quarter, and credit card delinquencies hit a record high.

“Even without the war we are expecting to see unemployment reach 6.5 percent by this summer,” Zandi said. “If we get bogged down in Iraq, I think unemployment will hit 7 percent and continue to rise into next year.”

Consumer spending accounts for two-thirds of all economic activity in the United States. A marked rise in joblessness, experts agree, could spell disaster for the financial markets. With the consumer carrying such a disproportionate burden of supporting the economy, there is little room for a major setback for households.

“If unemployment picks up, we’ll have a huge problem,” said David Tice, portfolio manager of the Dallas-based Prudent Bear Fund. “It is truly a house of cards with the U.S. consumer. They have too much home, too much car and too much debt and a lifestyle that’s very dependent on their paycheck.”

Still, if the conflict in Iraq is quick, experts say, there is a good chance the worst scenario — a double-dip recession — can be avoided.

“The most important thing going for the economy are productivity gains, and there are a number of important positives that will shine through if we get through the war in the next few weeks,” Zandi said.

On a positive note

Among those positives are historically low interest rates that will make it easier for companies to invest once confidence is regained. For the past year, the falling dollar has been a friend to manufacturers whose exports appear less expensive to foreign consumers.

Inventories are very low, and the rebuilding that a turn in the economy would necessitate also would give a nice boost. And then there is still that stimulus package sitting in Congress.

“I see evidence that the Fed is trying to help the consumer, but to a great extent the economy is in the hands of Congress,” said Gail Dudack, chief investment officer at SunGard Institutional Brokerage Inc. in New York.

But in the last quarter, the president ran up against resistance, with the Senate voting to cut his tax proposal in half.

“Increasingly, it’s going to be recognized that we have a budget deficit problem,” Tice said. “On the fiscal side, Bush may face more problems if the war doesn’t go well.”

Indeed, many market watchers are beginning to acknowledge, albeit begrudgingly, that Baghdad is not the only evil plaguing the market in the second quarter.

“How do we recover from all this excess capacity? I just don’t know,” said Charles Hill, research director at Thomson First Call, a firm that tracks and compiles earnings data. He said the aftermath of the recession seems to be more prolonged than the market anticipated.

The hope is that the war clouds will lift and give consumption a similar boost to what was seen in the direct aftermath of the last Gulf War. A boost on the revenue line would mean that companies could stop cutting costs to produce profits and possibly raise prices for a change.

“The market has been in a very well-defined trading range,” Dudack said. “The bottom end of that range is vulnerable to earnings disappointments, and we still have a number of uncertainties, but by the end of the year we could be breaking through the top of that range.”

Indeed, Dudack’s forecast calls for a rally to take place at some point before year-end. With the Dow just shy of 8,000 it would have to rise 15 percent to reach its December target of 9,200.

Energy’s rise

The one wrench in an equation that otherwise holds out the promise of a happy ending would be a protracted period of elevated energy costs.

“The critical element of the war is the cost of energy. The cost going up is a negative, but we could handle it if it were not for the weak job market,” she added.

There are beneficiaries to crude staying at or near $31.31 a barrel, where it closed for the quarter — oil companies. On the face, earnings expectations for the S&P 500 of 8.5 percent look fairly rosy. Energy company earnings, though, may be masking a weaker overall picture in corporate profits.

“If you took the energy sector out of the S&P 500 estimates, analysts are currently looking for 1.9 percent,” Hill said of the outlook for the 477 nonenergy companies in the index in the first quarter.

“Clearly energy is the best story of the quarter — and we know that’s transitory,” Hill added. “The odds are extremely high that second-quarter earnings will be lower than the first quarter. That clearly indicates we’ve hit a soft spot.”

As was the case the same time last year, analysts have once again called for a second-half recovery to propel the stock market to higher highs. In fact, in what Mr. Hill characterized as “blatant optimism,” analysts are calling for earnings on the S&P to be 13.2 percent in the third quarter and 21.4 percent in the fourth quarter.

“It’s like the shepherd boy crying wolf,” Hill added. “Maybe one of these quarters the wolf is going to appear. We’ll know a lot more by April. If analysts are back in the slashing mode, then we’ve got a problem, and the recovery is pushed out another year.”