Ed Yardeni's note : Friday morning, September 14, 2001
September 11 was a New Day of Infamy. The horror unleashed on this day is
truly unspeakable. I am in shock having lost friends, and knowing friends
who have lost family members, in the despicable sneak attack on thousands of
innocent people in the World Trade Center, the Pentagon, and the hijacked
planes.
The terrorists may soon be very surprised by the backlash against their
terrorism. George Bush, the President of the United States, in effect
declared all out war on them and their supporters. In his address to the
nation on September 11, he annunciated the Bush Doctrine: "We will make no
distinction between the terrorists who committed these acts and those who
harbor them." This is an important message. It suggests that the United
States will now hold nations that sponsor, support, and supply terrorists
accountable.
The administration's resolve will be tested by how far they will go to
implement this new doctrine. Will the United States insist that companies
providing nuclear, chemical, and biological equipment to terrorist states
cease doing so? The Iraqis have acquired fiber optic equipment to secure
their communications lines from attacks by the United States. The North
Koreans have acquired nuclear missile capability. Former U.S. Secretary of
Defense Richard Cohen recently said that the Clinton Administration had
foiled an attempt by a terrorist group to obtain a nuclear bomb.
Will the civilized nations join together to stop terrorism? I think the
latest act of barbarism will unite them in this effort. Already NATO has
taken an unprecedented step by invoking Article Five of its charter, which
states that any armed attack against one of its members is considered an
attack against all of them. The leaders of Pakistan and Egypt have stated
that their countries will assist the United States. American authorities
seem to be making a great deal of progress in identifying the terrorists and
their supporters, and a military response is expected soon.
What is the likely impact of this scenario on the global economy and
financial markets? There are many similarities between this year and the
early 1990s. The profits recession of 2001 has been tracking almost an
identical downward path as in 1991. The latest employment data suggest that
we are in a mild economic recession, as was the case from the third quarter
of 1990 through the first quarter of 1991.
Now, even the political and military crisis is reminiscent of the events of
the early 1990s. On August 2, 1990, Saddam Hussein launched a sneak attack
on Kuwait. By August 9, U.S. military forces were arriving in Saudi Arabia.
On January 17, 1991, Operation Desert Storm began. It was all over by the
end of February.
Before the war started, it was widely feared that Saddam had and would use
nuclear, chemical, and biological weapons. There was a tremendous sense of
uncertainty and dread. As a result, consumer confidence and spending fell
sharply during the fourth quarter of 1990. So did stock prices, which fell
19.9% from July's peak through October's trough. But once the war started
stock prices rebounded and so did consumer confidence.
Today, Americans are worrying that there might be more terrorist attacks in
the United States. The uncertainty is likely to depress consumer confidence
further. Consumer spending is likely to be weak during the third and fourth
quarters as it was in 1990, i.e. down 0.7% and then down 3.2%. Stock prices
may fall as much as they did in 1990, though I doubt it.
The end of the Cold War was bullish for stocks because it led to the
globalization of free trade and the proliferation of capitalism, a system
that promotes the interests and rights of the individual, including the
right to life. Today's terrorists seek to destroy this system. If the U.S.
succeeds in rounding up the immediate surviving members of the terrorist
cell quickly, including those in the Middle East, then stock prices might
rebound on the news. It would also be very positive if nations unite to
destroy the global network of terrorists.
Of course, the Federal Reserve is likely to respond to the crisis by cutting
the federal funds rate more quickly than previously expected, and rates are
likely to remain low for the duration of the crisis. The three-month
Treasury bill rate recently plunged below 3%. The bond yield may rise as
Congress responds with emergency spending. Already $40 billion has been
committed to helping the victims of the attack and rebuilding the devastated
section of New York City. The yield curve spread is widening, which is a
leading indicator of economic growth. While the crisis might push the
economy deeper into a recession over the rest of the year, it might be
stimulative next year.
White House officials and some Congressional representatives seem to be
preparing the country for a long protracted war against terrorists. An
invasion of Afghanistan is possible with the objective of destroying the
Osama bin Laden organization. It won't be easy. The Russians lost in their
attempts to control the country. But that was because the U.S. supported the
country's resistance fighters. This time, it is unlikely that any nation
will provide support. Of course, it is also possible that the U.S. will
launch a bigger offensive against the terror network that might bring the
U.S. into renewed fighting with Iraq. An attempt to strike at Hizballah
could broaden the conflict to include Iran.
In a more protracted conflict scenario, oil supplies from Iraq and Iran
might be disrupted pushing prices higher. However, other oil exporters
including the Saudis are likely to make up much of the shortfall. The U.S.
government budget surplus would certainly shrink significantly as defense
spending rose to meet the immediate military challenges and to bolster the
future defensive and offensive capabilities of our military.
Stock investors may turn defensive given all the uncertain scenarios and
outcomes. However, most defensive stocks, especially consumer staple are not
cheap. They have very high valuation multiples. Health care stocks also have
high multiples, but their earnings are likely to grow at a faster and more
predictable pace. Recently beaten down electric and gas utilities are also
likely to be favored by investors looking for some stability. Bank stocks
should benefit from the steep yield curve with short-term deposit rates well
below loan rates and bond yields. After the World Trade Center disaster,
many companies are likely to spend more on information technology backup
systems and wireless systems.
On September 11, I caught a flight to Charlotte, North Carolina to visit
with accounts. It left at 8:30 in the morning from LaGuardia. At 10 a.m.,
the pilot announced that he needed to speed up to land our aircraft in
Charlotte as soon as possible. He informed us that the Federal Aviation
Administration wanted all planes in the U.S. to land immediately because two
commercial jets had just crashed into the World Trade Center, another had
crashed into the Pentagon, and a fourth crashed in Pennsylvania. A colleague
from our Atlanta office met me at the airport. He had rented a car just
before hundreds of planes landed in Charlotte. We drove down to Atlanta to
take him back home. The next day I drove myself back home through Georgia,
South Carolina, North Carolina, Virginia, West Virginia, Pennsylvania, and
New Jersey to Long Island. During the 15-hour drive, I listened to talk
shows on the radio while passing many Civil War battlegrounds. The country
is united and ready to go to war again against terrorism.
Ed Yardeni
Chief Investment Strategist
Deutsche Banc Alex. Brown
New York City!
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