Dear Clients and Friends,
We spent much of the weekend sifting through news
and analysis regarding both political and economic developments for the
week to come.
In the week to come, we expect US stocks to be
severely tested, falling perhaps as much as 10%. This may not happen in
the first day, but investors anxious to raise cash or facing margin calls may
well sell into rallies, taking stocks lower.
We will put out another update tomorrow morning
before the US markets open describing overseas action and the direction of
pre-market trading. Over the weekend, the NYSE and NASDAQ conducted a
successful test of participants operational capacity. The SEC has
relaxed rules, permitting, for example, companies to buy their own stock at the
open to support the market.
It is highly likely that the Fed will cut the Fed
Funds rate by 0.50%. This has already been accomplished de facto by
flooding European and American markets with dollars - the 2 year note, which is
most sensitive to the Funds Rate, traded to a yield of 2.86% which is well under
the current Fed Funds rate of 3.50%. The Fed may hold the actual
announcement of the cut to a moment where the markets really need a
psychological boost. The European Central Bank, or ECB, which did not cut
rates last week at a regularly scheduled meeting, may work in concert with the
Fed this week to cut rates. If rates on dollar assets fall too far below
rates on Euro assets, there could be a run on the dollar.
US airlines have announced widespread layoffs and
schedule cutbacks of 20%. Potentially, the increase in costs and reduction
in revenues over the next 6 months could bankrupt the industry (but we expect
Federal intervention to prevent this.) We don't hold any airline stocks in
our portfolios (other than Boeing, which may rally since Boeing is a
defense contractor as well as a builder of civilian
aircraft.)
Insurance companies, for the most part, have the
reserves to pay claims from Tuesday's attacks; they will liquidate stocks and
bonds in their portfolios to accomplish this, putting pressure on stock and bond
prices for a while. We have positions in AXA and American
International Group which may fall somewhat.
Brokerage firms like Morgan Stanley, Goldman
Sachs and Lehman Brothers will have a tough time delivering earnings for the 4th
quarter. It has not been a good year for fee income on Wall Street, and
little business will be done through year end as a result of last week's
disruption. We have positions in Lehman Brothers, one of the better
performing companies this year, and American Express which is well diversified
beyond stock brokerage.
The price of oil, which briefly rose over
$30/barrel, settled back by the end of the week to $27.63/barrel. Fears
that oil supplies will be disrupted by war in the Middle East drove prices
higher initially, but demand is likely to be depressed by slow growth in the
world's economy later this year, and a sharp decline in demand for aviation
fuel. OPEC ministers have said that they may increase supplies to make up
for a revenue shortfall caused by lower average prices which will push prices
even lower. We have positions including Exxon/Mobil, BP-Amoco and various
drilling equipment companies.
Over the next 6 months, it is widely expected among
economists that the US economy, which was skirting recession, will fall into
negative growth for at least one if not two quarters (perhaps as low as -3% on
an annual basis.) Consumer confidence, which was shown earlier this week
to be at an 8 1/2 year low prior to the terrorist attacks, may well go lower,
harming sales of such consumer durables as cars and home furnishings.
House sales should slow as well even though mortgage rates are at the lowest
levels in a generation and will likely go lower. We have no exposure to
automobile stocks and our retail exposure is limited to such stalwarts as Home
Depot and Walmart. Healthcare stocks, whose earnings will remain steady
even in a recessionary environment, may rise in the near term. Consumer
non-durables such as Proctor and Gamble and Gillette should also hold
steady.
To a certain degree, the economy will be stimulated
as money is spent to rebuild in New York and Washington, but such a rebuilding
effort does not increase the overall wealth of the economy (because that money
would have otherwise be spent on other activities.) Over time, as current
uncertainties are eliminated, the economy will recover and we'll get back to the
upward trend in stock prices we've been expecting recently.
In our Thursday and Friday updates, we expressed
our hope that necessary military actions enjoy broad international
support. Since these updates, Osama Bin Laden has been identified as a
prime target and Afghanistan as his current host country. On Friday, we
talked about how difficult it would be to conduct operations in
Afghanistan. However, by Sunday, the Pakistan military government had
agreed to offer broad support. Additional support was offered from the
unlikely sources of Iran and Syria. The mutual self-defense clause of the
NATO Treaty was invoked; Germany, Britain and France among other western
countries have declared their support. The State Department is pursuing
multiple avenues to track down not only Osama Bin Laden but other aligned
terrorist organizations.
At this time, we don't know how the military
options will play out. In conventional wars, there are command structures
to attack, territories to obtain. In this war, the enemy hides among
civilians both at home and abroad; there's no command structure, no territory
but great risk to innocent lives. To succeed in this war, the United
States must work hand in glove with many unsavory characters to identify and
capture individual terrorists and break up individual cells. This effort
will take years. The United States in addition must adopt policies which
remind the nations of the world what the US has done for them. For
example, western countries, primarily the United States, provided $100 million
in food aid to Afghanistan last year to reduce famine caused by two decades of
war and four years of drought. Such largesse has not won the hearts
and minds of the Afghanistan government. We must avoid actions which
create future enemies, for example, by avoiding indiscriminate bombing
campaigns.
As always, we are available by phone and e-mail to
discuss clients' individual situations.