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A Time for Prayer

The tragic attack in New York City and Washington D.C. really puts economic and capital market analysis in its proper perspective. I'm sure I'm not the only one that found myself hugging my daughters a little more than usual or checking on them one more time before going to bed. My heart and prayers go to every one this terrible tragedy touched.

Unfortunately, this attack will have a dramatic affect on the economy and add to the uncertainly of any meaningful recovery. Since the economy was on teetering on the brink of recession, there is little doubt that the attack against the World Trade Center and Pentagon last week will hasten the fall in to recession and eliminate any chance for a second half recovery.

The airline industry and lodging industry are the first to feel the affects. As the airline companies cut capacity by about 20%, they are expected to layoff around 100,000 workers. Already American, United, and Continental have announced layoffs over 50,000. Boeing has announced another 30,000. Richard Anderson, CEO of Northwest, said Northwest lost $250 million to $300 million during the FAA mandated grounding. Now "Chapter 11 is a reality for the whole industry, not just Northwest." Merrill Lynch now expects the airlines to lose $6.5 billion, triple the $2.2 billion it expected before the attack. Merrill analyst, Mike Linedberg, said without a government bailout "it is only a short time before carriers are forced to file bankruptcy." There is no doubt that the credit markets will be monitoring this situation very carefully. The government is working on a bailout plan for the industry, but is running into some opposition in the editorial pages throughout the nation. The Wall Street Journal today discussed how the airline industry is basically just a bad business. It has high capital cost and have inflexible union contracts for labor. The editorial said that some of the airlines should be allowed to fail, otherwise we are just rewarding inept management. Reminds me of something Carl Ichan has said. The easiest way to be a millionaire is to be a billionaire and buy an airline.

Hotels are reeling as conventions get put on hold and canceled. The majority of conventions are held in the autumn and make up a lot of business for hotels. This week the World Bank and IMF both canceled their meeting in Boston. They were expected to fill 2,500 rooms. New Orleans has lost conventions that were to bring 40,000 visitors bringing up to $50 million to the New Orleans economy.

Retailers are worried that the consumer will hole himself up in his house and not buy anything. This will have a dire affect on retails because they have added stores at a blistering pace and need consumers to increase their spending. I have discussed on several occasions that the retails are posting decent total sales growth, but same-store sales are very lack luster in several segments, namely apparel. Michale Niemira, writer of the Bank of Tokyo-Mitsubishi retail report, expects retail to remain sluggish until Christmas. This sluggishness "on top of the poor performance in recent months makes it even worse for retailers."

Consumers are already putting off big-ticket items like cars. One car dealer in Washington D.C. has sold only one car since the attack last Tuesday. However, the current slowdown could be due to the "CNN effect" instead of real retrenchment. Fearing more inventory buildup, Ford has already cut third-quarter production by 12%. CNW Marking conducted a survey over the weekend and expects domestic carmakers sales to be down 9% this month.

Estimates of what insures will have to pay out have been quoted as low as $5 billion to as high as $40 billion. Moody's issued a statement saying "Many of these initial estimates will prove to be insufficient, perhaps by a substantial amount…It is possible that some reinsurers will be unable to honor all their claims, leaving primary insurers to shoulder a heavier load." While S&P and AM Best have indicated that the insurance companies will be able to honor their commitments, Moody's is warning that "The full financial impact of these events may, indeed, have negative consequences for insurance company debt and financial strength ratings."

One aspect of this that is not getting near the airtime I would have thought is the fact that government surpluses are gone, at least in the near-term. With the government slipping back into deficit spending, it is likely that the long end of the yield curve will rise. This would end up slowing down the economy even more as mortgages rates along with the corporate rates would surely rise even more. Throw on a greater risk premium and companies looking for money will find it much more expensive. Corporate spreads have risen since the attack with AA corporate bonds widening by almost 11 basis points and BBB spreads ballooned almost 50 basis points. Continental Airlines has already stated that it will be unable to make a $70 million payment on one of its equipment trust financings.

Dow Jones, publisher of the Wall Street Journal, warned that advertising linage is down 35% for the third quarter compared to the third quarter a year ago. It also indicated that the drop off accelerated through the quarter as August linage was down 41%. It is safe to assume there will not be a substantial increase in September to save the quarter. Advertising from technology companies is by far the biggest drag, down 65%. Advertising in Europe fared much better, but was also down. During August, advertising linage in the Wall Street Journal European edition was down more than 20% compared to year ago levels.

The Fed has cut rates eight times for 350 basis points, plus fiscal stimulus to boot. All this was done while the economy was still growing and unemployment under 5%, and around 4% for most of the cuts. Now that a real crisis has hit the economy the Fed is left without any bullets. Plus, if anyone has noticed the rate cuts have not done a whole lot to shore up the sagging economy. The slowdown has come because expectations were set way too high and companies added capacity accordingly, not because money was too expensive to borrow. Demand has dried up and there are simply few capital investments that make sense, regardless of cost of capital. The overcapacity is widespread and will take years to work off.

There is a lot of talk about the overcapacity in the tech sector. However, the overcapacity problem is prevalent throughout the economy. In an address to the OECD, Tom Usher, chairman of USX, the largest U.S. steelmaker, said that global excess capacity is about 250 million tons a year, almost one-third of global production. Ian Christmas, secretary general of the International Iron and Steel Institute, said the industry's short-term outlook is "disastrous" and is "bad and getting worse."

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