What We Can Learn About Markets from September 11

Image: Jason Powell (Flickr)

September 11, a Retrospective Account of Investment Fallout and Recovery

I wasn’t in New York City on September 11, 2001. Just prior to 911, I had taken a position as CIO for a major Wall Street firm headquartered in lower Manhattan; however, the trading floor I was responsible for was about 50 miles east of ground zero. I took the position outside NYC to be closer to my home and family – the benefit of my decision became apparent all at once, at 8:45 am that Tuesday morning, then reinforced 18 minutes later.

Twenty-one years have passed since then, the children of the deceased are now adults, and financial activity is spread much further than one small area in lower Manhattan. Although much has changed, it’s important to look back and recognize how the investment markets handle devastation and, at the same time, recognize how humans here and around the world will band together when others need help.

Image Credit: Visual Capitalist

September 11, 2001

The opening bells at the New York Stock Exchange (NYSE) and Nasdaq were silent at 9:30 that morning. They remained silent until September 17, as traders and investors feared what their positions would be worth upon the reopening of the financial markets after the longest close on record.

Once reopened, the Dow Jones fell 7.1% or 684 points, setting a record at the time for the highest one-day loss in the exchange’s history. By Friday, the NYSE had experienced the greatest one-week decline in its history. The Dow 30 was down more than 14%, the S&P 500 plunged 11.6%, and the Nasdaq dropped 16%. In all, about $1.4 trillion in wealth disappeared during the five trading days. Since then, this record has only been surpassed once at the early stages of the pandemic.

In hindsight, the industries most negatively impacted make sense. Airlines and the insurance sectors lost tremendous value. A flight to quality made gold popular as the price per ounce leaped 6% to $287.  

Gas and oil prices quickly rose as fears that oil imports from the Middle East would be slowed or stopped altogether. Those fears lasted about a week; then, after no new attacks and a clearer understanding of the intentions of government officials, index levels returned to near their pre-911 levels.

The sectors that experienced major gains after the attacks include technology companies and certainly defense and weapons contractors. Investors anticipated a huge increase in government borrowing and spending as the country prepared to root out terror around the world. Stock prices also spiked for communications and pharmaceutical companies.

On the U.S. options exchanges, volatility in the markets caused put and call volume to increase. Put options, designed to allow an investor to profit if a specific stock declines in price, were purchased in large numbers on airline, banking, and publicly traded insurance companies. Call options, designed to allow an investor to profit from stocks that go up in price, were purchased on defense and military-related companies. Short-term profits were made by investors who were quick to execute.

The terrorism of September 11 will, doubtless, have significant effects on the U.S. economy over the short term. An enormous effort will be required on the part of many to cope with the human and physical destruction. But as we struggle to make sense of our profound loss and its immediate consequences for the economy, we must not lose sight of our longer-run prospects, which have not been significantly diminished by these terrible events. – Fed Chairman Alan Greenspan, September 20, 2001

Since September 11

Over the following 21 years, the major U.S. stock exchanges have taken steps to make physical disruption of trading more difficult. This includes dramatically increasing the percentage of trading that is electronic. While this has made the U.S. markets less vulnerable to physical attacks, it is feared that there is increased potential for cyberattacks. “As we have digitized our lives, which has generally been a great blessing, we have sown the seeds for even greater destruction in terms of the ability to hack into our systems,” said former Securities and Exchange Commission Chairman Harvey Pitt, who led the agency on Sept. 11, 2001. “That is today’s equivalent of a 9/11 attack. There is a potential ‘black swan’ event every single day.”

Major Market Indices Since September 11, 2001 (Source: Koyfin)

The investment markets have enjoyed above-average upward movement, despite the negative short-term impact of the black swan event. In the nearly 20 years since Sept. 11, the S&P 500, Nasdaq 100, and Russell 2000 Small-Cap index has risen more than four-fold. The bond market has also been strong (persistent low rates) despite increased borrowing to fund defense operations to finance America’s 911 response.

The U.S. economy itself has had long periods of expansion since 2021, even with the mortgage market crisis from December 2007 to June 2009, and the economic challenges from the response to the COVID-19 pandemic.

The costs, however, are likely to continue to be borne by taxpayers for generations. Interest-related costs alone on debt which financed military operations, including the long Afghanistan war, which was resolved last year when the U.S. withdrew after 20 years, and the protracted conflict in Iraq from 2003 to 2011, are high. The economic drag of these costs, while not fully measurable, are real.

The U.S. government financed the wars with debt, not taxes. Interest rates have been low, but taxpayers have already helped pay approximately $1 trillion in interest costs on the debt incurred to finance the two wars. These interest costs are expected to balloon to $2 trillion by 2030 and to $6.5 trillion by 2050 (according to the Watson Institute at Brown University). This places upward pressure on interest rates and places downward pressure on economic activity. One reason is that taxes used to fund interest costs take money from the economy without providing any stimulus or new material benefit.

Off Wall Street

September 11 radically changed the national mood and political environment. Polls and surveys taken just before the 911 attacks found Americans growing less certain about the direction of the country as a recession began to weigh down the ability to be optimistic. A full 44 percent of the country thought it was headed in on the wrong direction, according to the August 29-30, 2001 New Models survey.

Logic might suggest that after a successful attack, people’s attitudes toward the direction of the country would trend toward a worse future. Reporters, politicians, and spokespeople all predicted a terrible economic shock; their forecast seemed supported by the first week’s plunge in markets. But the events of that day seemed to give citizens purpose. In fact, statistics that indicated the “direction of the country” showed that optimism surged. An October 25-28 CBS/NY Times survey reported that people felt the country was headed in the right direction by a two-to-one margin. A sense of pride in who we are as a country and as individuals overcame negative economic news in an unprecedented way.

Take Away

It has been over two decades since what many of us think of as recent. The truth is, children born on September 11, 2021 or before are now of drinking age. But history can prepare us for new events. The market’s first reaction to tragic news is always down; when proven temporary, bargain hunters come in, then the market has always resumed its historical growth trend upward.

The markets now trade more digitally with almost no need for runners in lower Manhattan and far less open-outcry and paper jockeying by masses of people working for companies in one small section of Manhattan island. But the new threats are also real, a cyber attack on electronic records or transactions could be devastating in its own way.

Challenges even those caused by tragedy provide opportunity and even purpose. September 11, and its aftermath are proof of this.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=803387

https://www.weforum.org/agenda/2021/09/9-11-timeline-visualized-america-september-terror-attacks/

https://www.federalreserve.gov/boarddocs/speeches/2002/20020111/default.htm

https://www.visualcapitalist.com/wp-content/uploads/2021/09/911-terrorist-attack-timeline-full-size.html

https://www.brookings.edu/articles/flying-colors-americans-face-the-test-of-september-11/

Money Moving Out of Foreign Investments is Supporting U.S. Markets

Image Credit: Andrea Piacqadio (Pexels)

Why So Much Money from Overseas is Flowing to Soft U.S. Markets

In 2016, Mohamed El-Erian, chief economic advisor at Allianz, and President of Queens’ College, Cambridge published a book called The Only Game in Town. It was written during a period approximately halfway between the last big stock market sell-off and the 2022 bear market. In it he suggests the only reason investment dollars from overseas are flocking to U.S. markets is because we are “the cleanest dirty shirt.” In other words,  the U.S. economy and financial system may not be great, but it is far more appealing than the alternatives.  

Labor Day 2022 is now behind us, the S&P 500 is down 16% YTD, the economy receded during the first half of the year and its growth is probably still stunted. The U.S. Treasury index indicates that bonds are down 11% YTD, so why are international money flows moving to U.S. markets? Do investors from overseas think this is a buying opportunity, are we the “cleanest dirty shirt,” or is there something else?

There are probably a number of correct answers, which, when taken together, provides the reason. Investors need to be aware of the dynamics as flows into and out of the U.S. impact all of the country’s markets, including real estate and currency.

“The U.S. looks the least challenged in a very challenging world,” Christopher Smart, chief global strategist at Barings and head of the Barings Investment Institute told the Wall Street Journal. “Everybody is slowing down, but the U.S., because of the continuing strength of the jobs market, still seems to be slowing more slowly,” he added.

And the data shows just how much money is reaching our markets. Assets have been withdrawn from international stock funds for 20 consecutive weeks, according to Refinitiv Lipper data. Money flows have been in to U.S. equity-focused stock and mutual funds for four of the past six weeks.

The U.S., relative to large economies outside of the states is better; employment is strong, there are expectations that a long protracted recession isn’t likely, and consumer spending hasn’t faded, while price increases (inflation) have been tapered. 

Recent performance of U.S. markets has been impressive. Since the low point of the year (June 14), the small-cap Russell 2000 index is up 7.2%, the S&P 500 is up 6.5% and even U.S. Treasuries are positive despite the Fed’s stated intention of higher rates.

The S&P 500 has outpaced major stock indexes in Europe and Asia since hitting its low for the year in mid-June, meanwhile the pan-continental Stoxx Europe 600 has added only 2.9%, Japan’s Nikkei 225 has advanced 4.5%. Germany’s DAX and the Shanghai Composite have slid 1.3% over the same period.

Source: Koyfin

And there is one other self-fulfilling incentive for U.S. dollar-denominated assets; the dollar has surged to a 20-year high relative to a standard basket of global currencies. To date it is 25.2% stronger than the yen, it increased 12.2% higher versus the euro, and gained 15% above the British pound. Even with the U.S. major indices down, investor conversion back to non-U.S. native currency is a big win compared to what they would have lost. And for U.S. investors that were in international markets, they are better off having repatriated their dollars, even if they are down on the year.

The longer the dollar’s strength continues, the more the strength will feed on itself.

What investors should pay particular attention to now is anything that may trigger a turnaround, and money going back into international markets. This does not seem imminent, but it helps to know what is making “other shirts dirtier.”

Among Europe’s challenges are war-related supply shortages which have led to skyrocketing gas and electricity prices. Recently added to the list, Russia’s Gazprom PJSC said Friday (Sept. 2), that it would suspend the Nord Stream natural-gas pipeline to Germany. Winter is coming and the continent is on the path to a worsening energy problem, one that would add to upward inflation pressures for them.

China the world’s second-largest economy, has been severely weakened by the impact of its response to Covid-19. Other factors weighing on its economy are a real-estate downturn, heightened regulation of technology companies, and unusually bad weather. Weakness in China creates problems for economies around the globe since much of the world’s commodities and manufacturing come from the country.

A turnaround in these factors, such as a friendly resolution to the war, increased productivity from China, or lower inflation across Europe and the tide may turn causing more investment to gravitate away from the U.S., creating less demand for assets here. To date, there is no sign that any of these possibilities are imminent, and the longer the U.S. is the only game in town, the more money will be kept in U.S. dollar assets and the more upward pressure there will be on these assets.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.amazon.com/The-Only-Game-in-Town-audiobook/

https://www.refinitiv.com/en/financial-data/fund-data

https://en.wikipedia.org/wiki/Mohamed_A._El-Erian

https://www.wsj.com/articles/u-s-dollar-strength-lifts-americans-relative-spending-power-11662304836?mod=Searchresults_pos4&page=1

https://www.wsj.com/articles/investors-are-pouring-into-u-s-stocks-to-avoid-greater-turbulence-overseas-11662421967?mod=Searchresults_pos1&page=1

Will the Dollar and Securities Markets Sink When the War Ends?

Image Credit: Andre Furtado

The Story of War and Peace in the Currency Markets

There is a story of war and peace in the contemporary currency markets. It has a main plot and many subplots. As yet, the story is without end. That may come sooner than many now expect.

The narrator today has a more challenging job than the teller of the story about neutral, Entente, and Central Power currencies during World War I. (See Brown, Brendan “Monetary Chaos in Europe” chapter 2 [Routledge, 2011].)

Today’s Russia war (whether the military conflict in Ukraine or the EU/US-Russia economic war) is not so all-pervasive in global economic and monetary affairs, though it is doubtless prominent. The monetary setting of the story today is much more nuanced than in World War I when the prevailing expectation was that peace would mark the start of a journey where key currencies eventually returned to their prewar gold parities.

In the 1914–18 conflict, any sudden news of a possible end to the conflict—as with the peace notes of President Woodrow Wilson in December 1916—would cause a sharp fall of the neutral currencies (Swiss franc, Dutch guilder, Spanish peseta), a big rise in the German mark and Austrian-Hungarian crown, and lesser rises in sterling and the French franc. Today, in principle, a sudden emergence of peace diplomacy would most plausibly send the euro and British pound higher on the one hand and the Canadian dollar, US dollar, and Swiss franc lower on the other hand.

Mutual exhaustion and military stalemate are a combination from which surprise diplomatic moves to end war can emerge. These circumstances apply today.

Ukraine is falling into an economic abyss—much of its infrastructure reportedly destroyed and its government is resorting to the money printing press to pay its soldiers (see Kenneth Rogoff et al., “Macroeconomic Policies for Wartime Ukraine,” Center for Economic and Policy Research, August 12, 2022). General economic aid from Western donors (as against military aid) is running far short of promises. All these pictures of Russian munitions stores on fire may or may not have excited some potential donors, but they have not heralded any breakthrough.

The human toll—both amongst military personnel and civilians—fans Moscow propaganda that the US and UK are willing to conduct their proxy war against Russia down to the life of the last Ukrainian soldier.

Meanwhile there are these presumably leaked stories in the Washington Post about how President Volodymyr Zelensky betrayed the Ukrainian people by not sharing with them in late 2021 and early 2022 the US intelligence alerts about a looming Russian invasion. According to the stories, many Ukrainians resent that they were not warned by their government and do not accept its shocking excuses (for example, to prevent a flight of capital out of the country).

Is all this preparing ground for a possible power shift in Kiev that might favor an early diplomatic solution even in time for President Joe Biden to claim credit ahead of the midterms? Western Europe will be spared some pain this winter if the initial ceasefire agreement includes a provision that Moscow desist from turning off the gas pipelines.

The purpose here is not to predict the war’s outcome but to describe a peace scenario that is within the mainstream and to map out how the rising likelihood of its realization would influence currency markets.

The main channel of influence on currencies would be the course of the EU/US-Russia economic war. A ceasefire would excite expectations of big relief to the natural gas shortage in Western Europe.

Prices there for natural gas would plunge. In turn, that would lift consumer and business spirits, now depressed by feared astronomic gas bills and even gas rationing this winter. Massive programs to relieve fuel poverty, financed by monetary inflation, would stop in their tracks. The European Central Bank (ECB) could move resolutely to tighten monetary conditions as the depression fears faded.

We could well imagine that the peace scenario would mean the European economies in 2023 would rebound from a winter downturn. That would coincide with the US economy sinking into recession as the “Powell disinflation” works its way through—including continued bubble bursting in the tech space and residential construction sector plus a possible private equity bust.

A big rise of the euro under the peace scenario, though likely, is not a slam-dunk proposition. Russia might delay turning the gas pipelines back on until there is an assurance about its central bank’s frozen deposits in Western Europe. There has been chatter from the top of the Organisation for Economic Co-operation and Development (OECD) down that a reparations commission would sequester these.

More broadly, it could be that most European households are not cutting back their spending to the extent assumed in the consensus economic forecasts. Many individuals may have never believed that the high natural gas prices would persist beyond this winter. Then they faced, in effect, a transitory rather than permanent tax rise. Economic theory suggests that such transitory taxes, paid in this case to North American natural gas producers, have much less impact than permanent ones on spending.

There are still the deep ailments of the euro. How can the ECB ever normalize monetary conditions when so much of the monetary base is backed by loans and credits to weak sovereigns and banks (see Brendan Brown, “ECB’s Long Journey into Currency Collapse Just Got a Lot Shorter,” Mises Wire, July 23, 2022)?

In principle, the US dollar, and even more so the Canadian dollar, would lose from peace as they have gained from war. Both have obtained fuel from the boom in their issuing country’s energy sector. In neither country has there been aggregate real income loss due to the economic war—in fact, there has been a gain in the case of Canada. A further positive for the US dollar has been the boom in the US armaments sector—and this should continue beyond a ceasefire.

Peace will not deflect Europe from seeking to diversify its energy supplies away from Russia and to North American gas and to renewables. But we can imagine that in the long-run, Germany could have a comparative advantage in the renewable space; and North America could lose potential sales outside Europe to Russian gas at discounted prices. Russia is widely expected to prioritize a vamped-up construction program for LNG (liquid natural gas) terminals. These will enable the export of its natural gas to world markets.

Bottom line: peace is likely to be a negative for the US dollar. But transcending this influence is the huge issue of how and when US monetary inflation regains virulence.

About the Author:

Brendan Brown is a founding partner of Macro Hedge Advisors (www.macrohedgeadvisors.com) and senior fellow at Hudson Institute. He is an international monetary and financial economist, consultant, and author, his roles have included Head of Economic Research at Mitsubishi UFJ Financial Group and is also a Senior Fellow of the Mises Institute. Brendan authored Europe’s Century of Crises under Dollar Hegemony: A Dialogue on the Global Tyranny of Unsound Money with Philippe Simonnot.

The article was republished with permission from The Mises Institute. The original version can be found here.

Price Moves When Warren Buffett Buys and Sells (Based on May 16 SEC Filing)

The Big Price Impact on Stocks After Warren Buffett’s Most Active Buying Spree

Warren Buffett and Berkshire Hathaway (BRK.A, BRK.B) were actively spending down the company’s large pool of cash last quarter, just as they promised during their recent annual meeting. This makes sense as some stock prices are lower than they have been in years, and a few sectors are showing they could have plenty of upside potential. It makes even more sense when you consider that Berkshire Hathaway was sitting on $144 billion in cash. The inflation rate is now running above 8% and eroding the value of every unearning penny.

Jumping into the market can be costly if wrong, but investor’s ‘dry powder’ is being eroded with increased costs by the day – finding a place for money to grow by at least the inflation rate would seem prudent. The analysts at Berkshire Hathaway are certainly aware of this.

The positive impact of Berkshire showing confidence in a company is often all that is needed to exceed the near non-earnings holding a cash position. Below we look at three Berkshire Hathaway changed positions as reported on May 16, and then compare the stock’s price moves versus the overall market.

Where Did They Gain Exposure

As revealed by the companies 13F filed on May 16, as of March 31 Berkshire Hathaway added Citigroup (C), Paramount Global (PARA), and sold Verizon (VZ). There were older positions added to as well, such as Chevron (CVX), and Activision Blizzard (ATVI). But for the purpose of showing the power of Buffett’s believing a stock is attractive, or in Verizon’s case, no longer attractive, we’ll take a look at the market moves of these companies as of 1pm the day after the 13F was made public.

Source: Koyfin
The above chart of Citibank, Paramount Global, and Verizon from the beginning trading on Monday compares the stocks to the S&P 500 performance during the same short period.

The S&P, as reflected during the short period in this chart, beginning on the date of Berkshire’s 13F filing, shows the S&P 500 up 1.60%. This is substantial in a year when the index has mostly been delivering red to investors. Verizon was the most noteworthy sale of Buffett as they brought their position near zero. The company’s stock rose only 0.11%, well below the S&P benchmark performance.

As for the positions opened during the first quarter by Berkshire Hathaway, Citicorp shot up 8.28%. Paramount Global reacted even more strongly, rising double digits to 13.95%. 

Lessons

While an SEC-registered portfolio new holdings are kept close to the vest before reported in order to avoid insider trading problems, listening to what someone like Warren Buffett is saying at annual meetings and at other times can allow you to get a sense if they have been active, and in what industries. More important, is whether they are active buying or selling. For an investor that is holding a stock which a well-followed investor has decided to sell, can cause significant underperformance for at least the near term.

Other Pertinent Info from the 13F Filing

During the first quarter of 2022, the value of Berkshire’s US stock portfolio rose by 10% to $364 billion. Buffett had indicated the firm he manages has been struggling to find bargains in recent years. He blamed this on stocks swelling to record highs, fierce competition from private equity firms, and SPACs which increased competition and costs of acquisitions. Even Berkshire’s own rising stock price made it unappealing as a company stock buy-back.

A change of appetite took place in the first quarter of 2022. Berkshire bought $51 billion worth of equities and sold less than $10 billion in stocks. Its net cash reduction of $41 billion helped slash its cash pile by 28% to $106 billion. Q1 2022 marked one of the most active buying periods in Berkshire Hathaway’s history.

Take-Away

Well known, successful investors can either make a winner out of your holding or cause it to trade at a pace below the market. While knowing and trading on information before it is made public can get you in trouble, investors like Buffett do provide guidance. These hints as to their thinking and likely direction may help investors somewhat. This is why it always makes sense to know what they’re saying – it isn’t fun holding something they just reported sold, and the tailwind they create when you’re long the same company can be profitable.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.sec.gov/Archives/edgar/data/1067983/000095012322006442/xslForm13F_X01/primary_doc.xml

https://whalewisdom.com/filer/berkshire-hathaway-inc#google_vignette

www.koyfin.com