A Backward Glance
Did we know the story before September 11?

By Victor A. Canto, Chairman of La Jolla Economics,
and Christian Carrillo
September 25, 2001, 9:15 a.m.

he stock market declined approximately 10% in its first week back following the terrorist attacks on U.S. soil. On September 17, the first day of trading after the attack, the best performers included industry groups such as gold and electronics (defense). The worst performing groups included airlines as well as lodging and hotels. To be sure, one can easily build a story as to how the terrorist attacks altered the relative performance of these sectors. But there is more to the story than meets the eye.

Yes, it is true that gold is the refuge of the cautious, defense spending will now increase, and people are not likely to fly as much in the immediate future. So, one can attribute some of the market's relative performance to the incident. However, that is not to say that one should ignore the fundamentals.

The following table shows the five best and worst performing industries during the first day of trading after the market shutdown, as well as the earnings for these sectors during the first and second quarters of the year. The results are quite interesting and somewhat surprising to those who attribute the market's relative performance to the incident.

It is apparent that the worst performers either had negative earnings in their first two quarters (entertainment and gaming) or a major deterioration in earnings (automobiles and airlines). The one exception was lodging, which saw its earnings remain unchanged, although it can be argued that the sector was set to lag as the travel slowdown set in. Thus, looking at the earnings data, you can argue that the airline industry woes were anticipated.

The reverse story seems to apply to the industry groups that outperformed during the first day of trading. While the case for the defense and gold industries is fairly obvious, the case for tobacco, health care, and the S&L industries is not. The common thread tying together these industry groups is that — with the exception of gold — they all had positive and improving earnings in the year's first two quarters. Gold had negative, but improving, earnings.

Investors must now make a decision as to whether the market changed in a significant way on September 11, or whether the fundamentals will still be our guide. In large part, it appears that the relative performance we are seeing in the market is due to the fundamentals; and also that the layoffs we are now seeing are tied to an economy that's in the doldrums.

Today, the danger that the U. S. economy faces is one of a credit squeeze due to the financial system's inability to extend credit (because the net worth of the borrowers has declined). That is why we need a capital-gains tax-rate cut and an accelerated depreciation schedule for high tech. We need the federal government to jolt asset values in a positive way and get us back on the virtuous cycle.