Economic fallout: What lies ahead?

No one can predict what will happen in the coming months as the world tries to come to grips with the terrible events of September 11th. We have never experienced a situation like this before.

There are many political, economic, military and financial variables to consider. These can change from day to day or even hour to hour. However, we need to at least begin the process of attempting to understand where we go from here in terms of our economic well being.

William Sterling, chief investment officer of CI Global Advisors, was in Toronto days after the terrorist attacks to speak to financial advisors and analysts. It was supposed to have been the kick-off of CI’s fall promotion campaign for its mutual funds, but those events changed all that.

Instead, Sterling talked about how he sees the future. His company is based in mid-town Manhattan, only a few miles from the site of the World Trade Center.

Sterling is highly respected in the industry and spoke for more than an hour without notes about the short, medium and long-term future. He made a few key points. 

Recovery set back
He said the U.S. economy was jt starting to show the first signs of recovery before the attacks occurred. Now, that has been set back for at least some months. The fourth quarter will likely show an annualized GDP of 0 to minus 2 per cent.

We are in a V pattern, and we have not yet reached the bottom of the V, which would signal the market low. He expects that to happen in the next 30 to 60 days. But the timing will depend on forces that no one can forecast. Escalating military action, combined with more terrorist strikes, will exacerbate the market situation.

Upturn will be quick
When the upturn does come, it will likely happen quickly. A U curve, during which we bump along bottom for a long time, seems less likely. There are several reasons for this thinking:

  • Interest rate cuts and easing of monetary policy. He expects we will see aggressive moves across the entire G7, not just in the U.S.
  • The economic stimulus from the rebuilding of lower Manhattan.
  • A big jump in U.S. government spending in military, security, and other defence-related areas.
  • A decline in the value of the U.S. dollar, which will make American exporters more competitive internationally.

Military response impact
The size and scope of the U.S. diplomatic and military response will play a critical role in the timing. Sterling takes Washington at its word when President George Bush, Vice- President Dick Cheney, and Secretary of State Colin Powell warn of a long battle.

He expects the U.S. to target all countries that are known to give refuge and support to terrorist organizations. He expects they will “decapitate” the leadership in countries refusing to take meaningful action again such groups.

He singled out Afghanistan, Iran, Iraq, Syria, Yemen and Algeria as high on the list. Obviously, the hope is that in most or all cases diplomatic pressure may be enough. But that’s anything but certain at this stage.

Long-term view
Taking a long-term view, he noted that while the damage to New York was considerable, in property terms it was roughly on the same scale as Hurricane Andrew. The economy would be harmed temporarily, but the long-term strength and resilience of the U.S. should not be underestimated.

He also cited statistics that showed that in times of previous crisis or war, the initial market reaction had generally been to sell. But in most cases, six months later, the Dow was at a higher level than before the event happened.

(One notable exception was Pearl Harbor, where the Dow suffered a 6.5 per cent loss on the first trading day after the attack and then fell another 9.2 per cent in the subsequent six months. However, by the time the Second World War ended, the Dow had almost doubled in value.)

Key points summary
To summarize his key points:

  • It isn’t wise to make panic, knee-jerk decisions in these circumstances. Markets are ruthlessly efficient and have already priced the changed situation.
  • There’s a good argument to be made for a V-shaped recovery next year.
  • Keep a close watch on the Federal Reserve for more aggressive easing.
  • Keep watch on the political/military side. War and more terrorism will likely delay recovery.
  • Review your asset allocation. Make sure it’s right for the circumstances.
  • Relative to current interest rates, stocks now represent relatively attractive value.

Consumer impact
In response to questions:
Gold may move higher, but it’s not a trade to hold unless you expect a downward spiral that will take us into World War III. He doesn’t.

For most Americans, their wealth is concentrated in their home rather than in the stock market. Lower interest rates translate into lower mortgage rates, which will result in more cash in families’ pockets.

The U.S. dollar is likely to slide against the euro in the coming months. Historically, European stocks have outperformed U.S. markets in such situations. (In that connection, London was up sharply last week while New York was falling.)

Watch consumer stocks closely. They may fall quickly and become very attractive. Airline stocks could be interesting to contrarians. The reduction of schedules could be a blessing in disguise to an industry that has been suffering from severe overcapacity.

Reprinted from the Internet Wealth Builder newsletter.