From Barron's
May 28th, 2002
What if Terrorists Strike Again?
By DIMITRA DEFOTIS
After this weekend’s ceremonies of war and remembrance, with their echoes of Normandy and September 11, the question remains: What about the next terrorist attack?
The threat of terror is still very much with us, as several top U.S. officials warned recently. How the market would react to what may be the inevitable next episode will depend largely on the nature of that attack: A suicide bomber? A suitcase-sized nuclear weapon? Something we can’t even imagine?
“I think there is a discount in the market of about 10% for the uncertainties implicit in the war [against terrorism],” says Milton Ezrati, an economist with Lord Abbett funds.
“As the United States appears victorious and on top of the intelligence situation, that discount will shrink. And where the government appears to be losing control, the discount will get larger.”
Marvin Zonis, a political risk consultant, worries that a second major terrorist attack in the U.S. could have an even greater psychological impact on the public than September 11 did.
“I think a second attack would be a devastating blow to the well-being of American investors, which would mean a devastating blow to the market, and it wouldn’t return quickly,” says Zonis, who also is a professor of international political economics at the University of Chicago.
Why? It’s all about consumer confidence.
The first attacks hurt the travel and leisure industries badly, because terrorists used airplanes as weapons. But small-scale terrorism in an everyday place could ignite everyday paranoia. The average consumer doesn’t buy airplane tickets every day, but he or she does go to the mall or supermarket regularly.
“To the extent that another attack hurt consumer confidence and thus consumer spending, that would be a negative for the economy,” says Steven East, an economic and policy analyst at Friedman Billings Ramsey & Co., an Arlington, Va.-based investment bank and political research firm.
Personal spending was roughly 70% of gross domestic product in the first quarter.
A survey by the International Monetary Fund last December indicated that any sustained fall in confidence could cut real gross domestic product by one percentage point.
Right now, although unemployment remains high, strong retail sales and increasing industrial production show the U.S. economic recovery is off to a strong start, writes Bruce Steinberg, Merrill Lynch’s chief economist.
But another attack could stall the recovery, because companies may postpone longer-term business commitments or reallocate their cash, says Andrew Parmentier, another analyst with Friedman Billings Ramsey:
In the days immediately after the attacks, the U.S. lost $47 billion in economic output and $1.7 trillion in stock market wealth, according to economists Peter Navarro and Aron Spencer in the Milken Institute Review.
Who’s likely to be hurt most by another attack? The stock groups that were hit hardest after September 11. The IMF report listed airlines and associated travel industries, postal services and insurance as among the most vulnerable.
Some airlines have threatened bankruptcy, but insurers’ losses from payouts should be offset by higher premiums, and greater pricing power should benefit reinsurance companies like RenaissanceRe Holdings (see Weekday Trader, “Strong Reinsurance Demand Should Boost RenRe,” October 11, 2001).
As a hedge against the market, money is flowing into gold, which is at a two-year high near $320 per ounce. Gold-mining stocks have performed spectacularly, too: Gold Fields Limited, based in South Africa, and Newmont Mining Corp, based in Denver, have reached new 52-week highs, although some strategists say a correction is in the offing.
Many defense stocks (like Lockheed Martin and Raytheon) continue to hit new 52-week highs as they reap the benefits of increased military spending, and that probably won’t go away, either (see Weekday Trader, “With America Under Attack, Investors Play Defense,” Sept. 18, 2001).
Oil prices, meanwhile, reflect a $4.00 to $6.00 per barrel war premium, East points out. Another terrorist attack or a U.S. war against Iraq could push crude prices higher. Exploration and production companies have gained 25% since their lows last fall, but earnings could improve into 2003 given higher oil and gas prices (see Weekday Trader, “With Saddam in the Crosshairs, Oil Takes Off,” March 28, 2001).
Of course, as Ezrati points out, the market continued to rally during last autumn’s anthrax attacks, weeks after September 11. And he is confident that Americans will take a car or truck bomb in stride if it appears to be “the desperate act of a desperate people and our government maintained its initiative.”
But Zonis says a suicide bomber would be a humiliating blow to the American psyche, suggesting terrorists can strike anywhere at any time.
“My colleagues believe everything is priced correctly without emotion in the market, but [our] evaluation of a company’s income in the future is massively impacted by our contemporary emotional state,” Zonis says.
East speculates another attack could prompt investors to take money out of the stock market and put it into U.S. treasuries. The resulting bond rally could bring mortgage rates down to 6.5%, potentially spark yet another round of refinancing and thus give consumers more discretionary cash.
But, as Zonis points out, “just because there is a lot of money around, that does not mean it has to go in the markets.”
Especially if investors think it’s more prudent to hide it under the mattress.>> Barron's |
