Managed Money Reporter Newsletter — Issue 176, October 2001

Editors: Carl Spiess & Allan McGlade

Featured Articles

American Tragedy

After reflecting on the horrific attacks in the United States and the ensuing volatility of the markets, it is important to step back and consider how best to deal with markets in a crisis situation. An examination based on historical fact and sound investment theory would be the best place to start, but only after taking the time to come to grips with any direct personal connections you or your loved ones may have had with this tragedy. 

With CNN, CNBC and other such news services available to most North Americans, we all receive more news and business information than is likely good for us. The continuous feed of horrific images, angry terrorists, and dropping stock markets, may overwhelm rational thought, and call into question whether capitalism can survive, and whether a return to "normal" can ever be contemplated. And what to do with our investment accounts, after yet another month of declining values? The answer is to keep a diversified portfolio, and not lose sight of the long-term wealth creating effects of equity ownership. 

This will however be very difficult, as most people expect further terrorist attacks of some form or another, and the reality of the possibility of a prolonged conflict sinks in. To quote Michael Lee Chin, CEO of AIC Group of Funds: 

"We have no predictive abilities or control over global trends, natural disasters, political upheavals, currency fluctuation and devaluation, social unrest, bad weather or manic-depressive stock markets. We do, however have complete control over our own behaviour." 

While the scale of the devastation in New York on September 11th is immensely larger than anything ever experienced, it is not completely unprecedented. Many countries such as England and France, have sustained many years of terrorist attacks and threats, without having their civilizations come apart. 

Missing in the exhaustive coverage of the recent tragedies is that terrorist attacks, intended to destroy freedom and capitalism, have also occurred in the United States in the past. On September 16, 1920, anarchists loaded the common mode of transport of the time, a horse drawn wagon, with dynamite and drove it into New York City. The resulting bomb blast killed 30 and injured approximately 250 on Wall Street. Financial firms in the area such as JP Morgan were devastated. At the time, foreign led anarchists were leading a terrorist campaign, against notable Americans such as JD Rockefeller. As this was the first attack of its kind, market reaction, and that of US citizens and the rest of the civilized world was near panic worried that "everything had changed". It is important to note that despite these attempts, JP Morgan, Rockefeller's Oil Empire and capitalism have far outlasted those anarchist movements. 

In the chart below, we can see that shortly after a shock, such as war or a terrorist event, the market is unpredictable, but longer-term recoveries are inevitable. Noting past historical crises such as Pearl Harbor and the Gulf War, William Sterling, chief investment advisor at CI Global Advisors, stated that markets usually tumble immediately after a crisis, but are often higher a year later. "Much will depend on whether this turns out to be a one-off episode or whether it is followed by other terrorist acts or even a drift towards war if the U.S. decided to attack major terrorist sponsors." 

 DOW BeforeDateAfter 3 Months
After 1 Year
After 2 Years
Wall Street hit by terrorist bomb88.616-Sep-2070.6-20.3%71.0-19.9%101.013.9%
Pearl Harbor115.907-Dec-41102.1-11.9%115.0-0.8%133.415.1%
Puerto Rican Nationalists shoot 5 congressmen on floor of House413.701-Mar-55424.92.7%486.717.6%468.913.3%
Cuban Missile Crisis568.622-Oct-62675.518.8%747.231.4%877.054.2%
Iraq invades Kuwait2,899.301-Aug-902,455.0-15.3%3,017.74.1%3,395.417.1%
First WTC bombing3,370.826-Feb-933,540.25.0%3,838.813.9%4,011.719.0%
Oklahoma City bombing4,207.519-Apr-954,628.910.0%5,551.731.9%6,703.659.3%
Average Change   -1.6% 11.2% 27.4%

Source: Scotia Capital


What about the Markets?

As the initial shock begins to subside, you may be wondering about the implication on the financial world and on your investments. Since the U.S. market re-opened, we have seen rapid declines in all the indices, ranging from the TSE which was down 42% from its high, to the tech-heavy NASDAQ which saw a decline of 71% (as of 09/20/01). These declines were not entirely a result of the recent crisis in the U.S. A good portion of the drop occurred with the market correction in anticipation of a recession, and to correct the overvaluation of certain companies. The recent blow was definitely a hit that was unexpected as our analysts were mostly positive about a turn around of the markets being around the corner.

Naturally, the uncertainty is troubling. The good news, if there can be any drawn from this, is that you are being given an opportunity to buy in when the market is low, hopefully at the bottom. Many of you may be doing this through payroll or bank deductions and averaging down your costs. Another good point is that most of us have diversified accounts that are built that way to sustain any major hits, or at least minimize the danger of losses.

Mass euphoria or "irrational exuberance" as Alan Greenspan called it, has now been replaced by mass pessimism. A fascinating chronicle and evaluation of folly, Charles Mackay's Extraordinary Popular Delusions And The Madness Of Crowds is as relevant today as it was when it was first published more than 150 years ago. Be it the South Sea Bubble of the eighteenth century, the Dutch tulip markets of the 1600s or internet stock hype. Mass Pessimism, the direct opposite of Mass Euphoria, can also grip a crowd in the face of change and uncertainty. Eventually rational thought prevails, and capital is deployed in the most effective ways for shareholders to achieve returns.

This is explained by modern economic theory and capitalism, which continuously adjusts and reallocates resources. As per Adam Smith's "invisible hand" which theorizes that when each individual pursues his or her own advantage, he or she is "led by an invisible hand to promote an end which was no part of his intention," thereby doing more for society than he or she had deliberately set out to do. In other words, doing what's best for you is likely best for everyone.

We can all do better than to give up on capitalism and the symbols of international trade and cooperation that the World Trade Centre represented. We owe it to the victims of the air strikes, to rationally evaluate the world with our knowledge of history and human nature, and act accordingly.

For more on this topic, see our market volatility page.


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