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Stock Strategist

A Look Back at Dire Predictions from 9/11

How airlines, insurance, defense and NYC are faring after the attacks.

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The downing of the World Trade Center and the attack on the Pentagon on September 11, 2001, shocked the global financial markets. In the days following the terrorist attacks, the major world indexes plummeted, and we heard of 1930s-style depressions, permanent disruptions of global trading, and the return of Reagan-era defense budgets. Thankfully, few of these worst-case scenarios have materialized. Here's a retrospective of some of those prognostications and how they panned out.

Insurance Companies Will Falter
The 9/11 terrorist attacks will likely cost the insurance industry $40 billion to $50 billion, according to the Alliance of American Insurers. (For perspective, the entire pharmaceutical industry earned $50 billion in 2001.) That's an enormous blow for a single industry, and at the time of the disaster, many thought it was more than a few companies could swallow. Although the companies were not underwriting for such catastrophic losses, the industry has held up well; there haven't been any major failures as a result of the WTC and Pentagon attacks.

In fact, the sky-high premiums resulting from the newly perceived--and newly underwritten--risks have created a very favorable market (a "hard market" in industry parlance) for insurers. And while this new pricing level has drawn a crowd--$10 billion in new capital has poured into the reinsurance industry alone since 9/11--the companies that were well run before 9/11 should be on sturdier ground going forward. As long as they are appropriately pricing the risk (something we won't know for years), insurance companies should remain solid.

Berkshire Hathaway (BRK.B) was one of the hardest hit by 9/11. Warren Buffett's firm paid $2.4 billion in claims and added $800 million to its reserves to account for risks it failed to underwrite. But its stock has held up well, actually posting a 5% gain over the past 12 months.

NYC Office Space Will Reach 100% Occupancy
Realizing that workers will need new or temporary space in downtown Manhattan, experts predicted that occupancy rates would jump. Larry Silverstein, the developer leading the group that owns the 99-year lease on the World Trade Center, is still mulling over what to do with the site. Whatever he and the group decide, it'll take years to rebuild. Also, it's unlikely that all 25 million square feet (30% of the downtown Manhattan office market) of lost or damaged space will be rebuilt.

Thinking along those lines, investors jumped into real estate investment trusts (REITs), such as Vornado (VNO), Boston Properties (BXP), and Reckson Associates (RA), that own sizeable chunks of office buildings in and around New York City. But according to CB Richard Ellis, a commercial real estate services firm, occupancy rates in downtown Manhattan have actually fallen since the terrorist attacks. At the end of the second quarter of 2001, occupancy rates were 94.4%. A year later, they were 88.5%. Displaced tenants didn't bolt to surrounding areas in mass either. Midtown Manhattan and Northern and Mid New Jersey have also seen 5 to 7 percentage-point decreases in occupancy rates.

It appears that WTC tenants have found new space elsewhere and are in no hurry to return. A New York study reported that less than one third of the companies that lost space have returned, according to the September 4 issue of The Wall Street Journal. Throw in a struggling economy and a dismal financial market that has forced layoffs at many of the city's investment houses, and a drop in occupancy rates makes sense--now. A year ago, it seemed unfathomable given the size of the square-footage loss. Not surprisingly, Reckson, Vornado, and Boston Properties are all within 5% of their prices on September 10, 2001.

Air Travel Will Shrivel
The outlook for the airline industry was dire following the attacks, and many wondered if traffic would ever approach pre-9/11 levels.

Even before the terrorist attacks, the airline industry was hanging by a thread. September 11 simply made their position more precarious. Indeed, air traffic has yet to bounce all the way back. Monthly passenger traffic is only about 90% of its normal level. For an industry with a horde of other problems--including union contracts, which prevent airlines from cutting labor costs, and high fixed costs such as fuel and maintenance, which have been eating away at the airlines' bottom lines for years--even the slightest decline in revenue spelled trouble. On top of that, a fragile economy was already dragging down airline revenues, and ticket prices haven't rebounded either.

No airline can escape the impact of 9/11, and only a few are profitable enough to withstand the labyrinth of new costs and shrinking passenger lists. Southwest (LUV) has a business model that fits well with the airline industry's survival mode. As a low-cost provider, it can entice customers with its pricing while absorbing the new costs better than the competition because its margins were fatter to begin with. Besides, it was one of the few airlines to turn a profit in 2001, and we think its shares are undervalued. Until the health of the industry is more definite, however, investors should avoid most airline stocks, such as United (UAL) and AMR (AMR), in our opinion.

Defense Is the New Growth Industry
It's common sense that if we go to war or continue to bomb suspected al-Qaida hideouts, we're going to deplete our munitions. As we resupply, defense contractors are going to benefit. The pundits were right about this one.

President Bush's 2003 fiscal-year defense budget calls for the largest increase in military spending since Reagan's 1982 budget. Raytheon (RTN), the maker of the Tomahawk missile, is well-positioned to benefit, especially since the budget calls for $6.5 billion for missile-defense research and development. We also like Raytheon's improving cash flows. Years of shrinking defense budgets have left U.S. weapons systems--including aircraft and ships--in need of replacement and repair. This puts General Dynamics (GD) in the driver's seat as one of only two companies (the other is Northrop Grumman (NOC)) that can meet the Navy's shipbuilding needs.

Catastrophic events like 9/11 are going to disrupt markets, but the last year has proved that our economic system can withstand these blows. Changes, some temporary and some permanent, are to be expected, but when all is said and done, most companies and industries are back were they belong; those in trouble before 9/11 are still struggling, and those that were on solid ground are holding up.

Todd Lebor has a position in the following securities mentioned above: GD. Find out about Morningstar’s editorial policies.