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) "twin towers" 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 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.
Negative economic implications
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, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at firstname.lastname@example.org
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