A Current View

The tragic events of yesterday are almost too unspeakable for words. The loss of life and physical destruction of property is unparalleled in peacetime in our country's history. Because of the magnitude of the disaster it will be many months before the full tally of the losses will be known. As our President has requested we pray for all the victims of this tragedy.

In a time of extreme national sorrow it seems almost crass to comment on the effects these events may have on the financial markets. Yet our duty to our clients is even more acute when catastrophe strikes. We are charged with the responsibility of safeguarding their assets and with making reasoned judgements about what the future holds for their investments. Recognizing our fallibility, we believe both history and likely government response provide clues to the ultimate denouement. A review of stock market history shows that acts of terrorism against the United States have had little lasting impact on values.

Every crisis causes an initial decline in stock market values, just as the concurrent flight to quality causes a sharp rise in bond prices. Beyond the immediate reaction however the impact is more limited. The Federal Reserve has announced that it stands ready to supply all necessary liquidity to the financial markets. The Fed's rapid response to other financial crises in recent years adds weight to its stated intention. The fact that the Fed stands ready to supply liquidity, and to lower interest rates further will, in our opinion, forestall a financial panic which might otherwise occur.

Nevertheless there will be an economic impact, we believe. Caution on the part of the consumer will be heightened affecting such discretionary spending plans as vacation travel. Energy prices, which were firm prior to the attack, will certainly rise further in its wake. This has the same dampening effect as a tax increase on consumer spending. In the financial arena, risk aversion will replace risk taking as a standard of investment policy.

There are other underlying influences at work however. The inventory overhang which was the primary cause of the severe downturn in industrial production in the first half is abating rapidly. Neither interest rates nor inflation are impediments to growth, and will be even less so under current conditions. We have pointed out previously the very positive demographic and financial trends affecting the housing market. These trends continue and are augmented by the interest rate environment.

Furthermore, crises often expose areas of under investment or neglect in our economic infrastructure. The current episode, however repugnant, will also act as a catalyst for infrastructure investment of numerous varieties. Finally, additional stimulus in the form of further tax cuts are very likely as a result of the changed domestic economic outlook.

It has long been our belief that crises bring out the best of the American character and culture. As a people we are resilient and unlike some other nations, do not take defeat as a permanent condition. As shockingly gruesome as the current events are, we will rise above them. Our economy despite short term uncertainties will recover and be stronger than before. Neither national decline nor economic deterioration will result from this tragedy.

Investment Policy Committee
Alfred A. Lagan, CFA, Chairman
September 12, 2001