Investors Will Lose at Patriot Games

In the days following the Sept. 11 attacks, a call to financial arms echoed across the country.

In a quintessentially American response to the attacks, politicians and pundits voiced sentiments similar to those of Vice President Cheney, who encouraged Americans to "stick their thumb in the eye of the terrorists and ... not let what's happened here in any way throw off their normal level of economic activity."

Joining in were some Wall Street figures, who admonished Americans to "summon the patriotism to buy stocks," as Larry Kudlow, CEO of Kudlow & Co. and syndicated columnist, wrote shortly after the attacks.

The "patriotic investing" sentiment gathered momentum during the stock market's closure from Sept. 11 through Sept. 16. A grassroots email campaign spread the (literal) rally cry.

The idea received considerable attention, but subsequent market action showed there was no broad support for it. While patriotism might have influenced some investors' behavior, the dollar and U.S. stocks fell swiftly and steadily in the days after Sept. 11. Those who invested blindly for patriotism's sake lost money. It's a lesson worth remembering as the war on terrorism continues and possibly expands into Iraq.

"We are fiduciaries for our clients and are going to have to act in their best interest, not throw money at the market because it's a patriotic thing to do," said Brett Gallagher, head of U.S. equities at Julius Baer Asset Management. Gallagher, who oversees about $4 billion, was responding to a question about his thinking a year ago and potential future geopolitical events.

Most investors, individuals and institutions followed a similar credo after Sept. 11.

Emotions in Motion

When trading resumed on Sept. 17, the Dow Jones Industrial Average suffered its worst point decline in history, although its 7.1% drop was not among its 10-largest percentage declines. The New York Stock Exchange set a then-record level of volume at nearly 2.4 billion shares, while declining stocks swamped advancers by 7 to 1.

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Wall Street Shocked Into Exodus

The selling continued for several days; the week the market reopened the Dow lost 14.2%, its fifth-worst weekly percentage decline in history and the biggest in the post-World War II era. Meanwhile, the S&P 500 shed 11.6%, and the Nasdaq Composite declined 16%.

Before bottoming on Sept. 21, the Dow suffered a nearly uninterrupted 24% decline from its Sept. 10 close, one at least matched by other major averages.

Despite calls for individual investors to rally around the flag, equity mutual funds suffered outflows of $29.5 billion in September, according to the Investment Company Institute. That then-record level of outflows wasn't topped until July 2002.

Still, the market's pattern immediately after reopening Sept. 17 suggested some reaction to the patriotic investing call.

"I think there was a patriotic response the day the market reopened, the selling was relatively moderate," recalled Vincent Farrell, chairman of Victory Capital Management, which manages over $70 billion. "Selling did accelerate but there was no panic, nobody tried to make hay" off the tragedy.

Farrell noted there were some informal agreements in the hedge fund community to not aggressively short shares after the attacks. There was similar talk about foreign exchange trading although, again, such rhetoric was not matched by the reality.

"The dollar was aggressively sold from the moment the attacks happened for the next four days," recalled David Greenwald, who was head of U.S. foreign exchange trading at Bank of America last September. "I do not recall anyone having any hesitation to sell the dollar," which was the most liquid way for fund managers long U.S. equities to hedge themselves during the stock market's halt.

The week of Sept. 10, the dollar fell to as low as 116.93 yen from a high of 122.05 before the attack, reported Greenwald, now a partner at Scalene Partners, a currency-focused hedge fund in Westport, Conn. The greenback experienced similar, although less dramatic moves vs. the euro and other currencies. The following week the dollar fell to as low as 115.82 yen before bottoming in concert with equities, which rallied strongly in the fourth quarter.

From its low on Sept. 21, the Dow proceeded to rally nearly 30% until peaking in mid-March, while the S&P rose more than 20% and the Comp gained more than 40% from their respective troughs. But those gains disappeared amid the fallout from Enron's Dec. 2 bankruptcy filing and late June's WorldCom scandal. Concerns about corporate malfeasance were paramount in July when the September lows were breached.

"Everyone was trying to be patriotic but it was our own country that really in the end brought us down," suggested Ellen Anapolle Paola, a local sales manager at radio station WDHA in Morristown, N.J. "We were getting past [Sept. 11], then Enron and WorldCom hit."

Despite hearing the patriotic investing message, Anapolle Paola didn't put money into stocks last September. But that's mainly "because I already had so much in" equities, she remembered. Heeding calls not to panic and aid the terrorists, she didn't sell after Sept. 11. She feels corporate wrongdoers have done far more damage to her portfolio than foreign terrorists have.

Finer Points Lost

Kudlow defended his call to patriotic investing in a recent interview: "At the moment the [planes] hit and destroyed those buildings, it was clear these people were trying to strike at our economic system of market capitalism. Since the stock market is a symbol of that, to buy and shove it in Osama [bin Laden's] face -- I thought if people could do it, they should."

Victory Capital's Farrell was another of the high-profile market figures who became associated with the same theme.

During a Sept. 13 appearance on CNBC's Squawk Box, he said, in response to a question about what Fed Chairman Greenspan and other policy makers could do to support the market: "Just appeal to all of us, a basic patriotism, that speculators speculate tomorrow. Don't speculate today. Let's stand together."

On Sept. 18, The Wall Street Journal quoted Farrell as saying he'd be buying shares of IBM , Tellabs and UnumProvident , among others, following the declines on Sept. 17.

In addition to being patriotic, "this has the extra bonus of being the right thing to do for our clients," Farrell reportedly said.

Last week, Farrell said his role in raising the patriotic investing sentiment was an unwitting one.

"I didn't mean it like 'wave the flag and buy America,'" he said a year later. "I said, 'this is not the time to profit from the decline,' that any decline was going to be short-lived, because it always is after a crisis."

Farrell's point was that trying to profit from the attacks was both immoral and poor money management. But saying "don't sell" is a subtle and important difference from advising people to buy shares for patriotic reasons.

Also open to interpretation was the Sept. 13, 2001 statement from the California Public Employees Retirement System, which had nearly $100 billion invested in equities (including $62 billion in U.S. shares) at the time. The fund issued a statement expressing its "confidence in U.S. financial systems and money markets." The pension fund also declared it would "provide stability in the U.S. financial markets."

Calpers' statement was an expression of its sympathy with what transpired on 9/11, spokesman Brad Pacheco said in a recent interview. But as the pension fund pointed out shortly after the statement was released, it also reflected CalPERS' belief that attractive bargains were likely to be created when the market reopened, something that may have been lost in the translation.

"No matter what happens we haven't changed our investment strategy," which is "patient money is smart money," Pacheco said. But "if we can see an opportunity with the market being down," the pension fund will act accordingly -- but not chiefly for altruistic or patriotic reasons.

"As a fiduciary advisory, we're not going to do it just to do it, but [only] if we see an opportunity as investment managers," he said.

Here and Now

On Sept. 18, 2001 I wrote that patriotism is a poor investment guide, and stand by that argument. Investing based on emotions -- and patriotism is almost pure emotion -- is almost always a mistake.

Giving to charity -- which Americans did in huge numbers after Sept. 11 -- seems far more appropriate than blindly throwing money at equities.

Last December, investors were offered another alternative when the Treasury Department -- after initial reluctance by Secretary O'Neill -- approved the sale of so-called Patriot Bonds. However, these modern equivalent of War Bonds are similar to other Series EE bonds in every way except name.

"Proceeds of all Treasury borrowings go into the general fund" and Congress then decides how the money is appropriated, explained Peter Hollenbach, a spokesman for the Bureau of Public Debt. "There is no discussion of [offering] securities earmarked" for the Defense Department and/or the Office of Homeland Defense.

That's unfortunate because there's an opportunity for the government to marry the desire of many Americans to make a direct financial contribution to the war effort and the financial strains on the military; just last week The Wall Street Journal reported on the Navy's cash flow shortage.

I suspect many Americans would be willing to sacrifice a few basis points of yield to purchase bonds that assure a direct connection between their investment and the war effort.

That is a patriotic investment worth supporting for the intent, and the returns would be well defined.