Monumental destruction hits U.S.
Economic
and financial impact of terrorist attack
As all of
you know, the heart of the United States’ financial district was the target of
a vicious and coldly calculated terrorist attack Tuesday – effectively killing
thousands and destroying the 110-story World Trade Centre (WTC) in lower
Manhattan. Our most heartfelt thoughts and prayers are with the deceased and
their loved ones. While words cannot express the sadness many of us feel, part
of dealing with this horror is to continue living our lives. That said, many
investors have been questioning the safety of their investment portfolios. The
truth is there simply aren’t a lot of concrete answers, but I hope the
following will provide a bit of insight and comfort into the financial and
economic implications of this week’s events.
With the
collapse of the WTC’s “twin towers” still very fresh in our minds, the first
impact people think of is the resulting level of claims that property and
casualty insurance companies will face. Estimates of total claims are ranging
from US$5 billion to more than US$30 billion, but nobody knows for sure. While
two of the world’s largest insurers, Munich Re and Swiss Re, are reported to
have insured the twin towers, it’s not yet clear what claims they will face. If
history is any indication, the global insurance industry is capable of
withstanding large claims. Hurricane Andrew, which caused major destruction in
the U.S. a few years ago, resulted in insurance claims of nearly US$18 billion.
What has
yet to be mentioned are the potential claims on lives lost in the buildings’
collapse. However, even with the potential death toll ranging from 10,000 to
20,000 in a worst-case scenario, this would not pose a threat to the financial
condition of the life insurance industry.
For months,
North America has been seeing a negative trend in economic figures like GDP
growth, unemployment, inventories and capital spending. With the bottom not yet
in sight, this week’s terrorist attack risks pulling the carpet from under the
already limping North American economies. While I don’t expect any long-term
negative consequences, make no mistake about the fact that the attack on the
U.S. has very real economic consequences.
Airline
stocks will likely feel the largest hit, as individuals now fear flying in the
midst of this terror. If oil prices remain higher, that will increase airline
companies’ costs. Even if that doesn’t happen, beefed up security will slow the
pace of air travel and increase costs. All this contributes to lower bottom
lines. Hong Kong’s largest carrier, Cathay Pacific, has dropped like a stone
since Tuesday’s attack and is now trading at more than a quarter below its
stated book value.
While property and casualty insurers have also been battered in overseas stock trading this week, it’s still very unclear if any exemptions (i.e. for acts of war, terrorism, or God) will kick in to block any claims. Based on activity since the attack, the market is apparently not yet clear on this crucial issue. The market won’t be able to make up its mind until the lawyers get out their magnifying glasses to check out insurance policy fine print.
The ailing
auto industry has suffered somewhat as a result of reduced air travel and
heightened security at all Canada-U.S. border crossings. Border crossings in my
hometown of Windsor Ontario (the auto industry’s main artery) are experiencing
delays of several hours, thereby slowing the transportation of auto parts.
Since auto manufacturing plants have inventory arriving daily from suppliers by
truck and plane, many shifts have been cancelled this week, causing a loss of
production during this already slow period. Customs have not yet formalized an
action plan for maintaining high security without prohibitively long delays.
As a
result, we should all expect the economic statistics for the third quarter of
this year to be substantially weak. In spite of this, it’s not all doom and
gloom.
From an
economic and financial standpoint, there are some positives. To ensure that the
U.S. financial system maintains its integrity, the Federal Reserve, in united
fashion with all G7 central banks, have committed several billions in currency
to make sure no institutions fail as a result of cash flow problems resulting
from this disaster. All central banks have also issued very stern warnings to
hedge fund managers and other speculators that the manipulation of financial
markets to make a quick profit will not be tolerated. In fact, central banks
have committed to actually jumping into financial markets themselves if they
suspect any market manipulation is taking place.
Also, the construction industry should see a boost, based on
the assumption that rebuilding/repairing will be done on the WTC, the Pentagon,
and buildings indirectly damaged (structurally) by fire and debris. What if
they don't rebuild the 110-story WTC towers? Then the New York real estate
market may be a big beneficiary since the employers of up to 40,000 workers
will be looking for new office space. While the negatives definitely outweigh
the positives here, it's not all bad news.
The
consensus among fund managers seems to be that this catastrophic event does run
the very real risk of tipping us into a global recession. However, opinions are
somewhat divided as to whether or not that will actually happen. At this point,
most are not expecting a recession much worse than what was already happening.
The key, of course, is the impact on consumer confidence. Ironically, this can
be a self-fulfilling phenomenon. If consumers are sufficiently rattled by this
event such that they stop spending, we will surely slip into a recession. If,
on the other hand, consumer confidence remains relatively strong, we have a
very good chance of coming out of this in decent financial and economic shape.
The key is the American consumer.
Most
managers also agree that history suggests such crises result in shorter-term
stock declines followed by strong gains in the subsequent one-to-two years. The
problem with this reasoning is that we have never experienced such a colossal
crisis so close to home before. While history must be used as a guide, it
should be understood that there really isn’t a good precedent upon which to base
any predictions.
John Hock,
manager of CI Global Value fund, has committed to placing more money into
defensive stocks in an effort to soften what he thinks will be a difficult
time. However, he holds out a healthy dose of optimism for the next year as
near-term weakness creates investment opportunities. Demographics expert and CI
fund manager Bill Sterling shares these views but is maintaining a neutral
asset mix of 60 per cent stocks and 40 per cent bonds and cash.
Managers of
Templeton funds are literally reassessing each of their stock holdings to
evaluate the potential impact of the attack on their outlook for each stock.
Aside from the liquidity supplied by central banks, they also expect that rates
will be lowered if they sense their respective economies experiencing a
deepening slowdown. George Morgan, lead manager of Templeton Growth, says the
five-year outlook for the profits and cash flows of airline stocks are being
very heavily scrutinized. This will likely result in a significantly lower value
estimate compared to pre-attack levels. Leslie Lundquist, manager of Bissett
Income fund, reassures us that none of the operations of any of the income
trusts held in her fund will be materially impacted. In fact, the energy trusts
in the fund could provide a boost if upward pressure on oil prices resumes.
Many other
managers share these thoughts and add that the key to assessing future
implications will be the determination of the responsible individuals, the
nature of the U.S. retaliation, and the extent to which this
“war-in-the-making” escalates.
The truth
is nobody really knows what’s going to happen in the next several days, weeks,
and months. All indications are that this situation will escalate to a
significant retaliation. Unlike many other times of market uncertainty, this
time is clouded with political risk and uncertainty. My advice is to continue
to hold current investments. There simply isn’t anything to suggest that
moving, en masse, to cash or hard assets is the best thing for investors. If
you have new money to invest (i.e. inheritance, pension transfer, etc.), I
would recommend a more conservative entry strategy. Rather than investing all
at once, I would suggest averaging in over a period of 12 to 24 months and accelerating
that pace as opportunities present themselves. Energy and gold stocks are good
hedges but don’t go overboard – a good rule of thumb is 20 to 25 per cent of
equity holdings.
Following some basics of prudent investing and asset
allocation (i.e. don’t forget bonds) should help in providing some comfort to
investors and minimizing the financial impact on portfolios. Remember that
times of crisis typically present good opportunities for patient and
opportunistic investors.
Dan Hallett, B.Comm.,
CFP is Senior Investment Analyst with Sterling Mutuals Inc. He can be reached
at dhallett@sterlingmutuals.com Sterling Mutuals Inc. is registered as a
mutual fund dealer in Ontario, British Columbia, and Manitoba.