With the terrorist attack of September 11th still fresh in our memories, it's much too soon to judge the episode's long-term economic and political impact. But all of us can vouch for the event's emotional shock: a continuing stream of horrific images played over and over again. The gruesome pictures have come one after another, just as each victim's story has seemed even more compelling than the last. We at Harris Associates share this grief and offer our condolences to everyone affected by this national -- and personal -- tragedy.

It's been tough on the market as well, although we admit it's uncomfortable for us to consider such human and financial-related difficulties in the same discussion. The tragedy truly extends across physical, psychological, cultural as well as economic boundaries. Try as one might, it is impossible to consider this aggression in a vacuum, and likewise, for us and our clients, it would be foolish to ignore its impact on the global economy and our financial markets.

In the days immediately following September 11th we heard a lot of people say, "The world has changed." In fact, the U.S. financial markets shut down for four consecutive days (the longest such period since 1929), the FAA closed all U.S. airports for the first time ever, and unprecedented shutdowns affected Broadway, baseball, football and other major entertainment and sporting events. And today, weeks later, we as a nation face the prospect of a protracted war on terrorism, new limits on our personal freedoms as well as restrictions on commerce within and across our borders. After a quarter century of effort to reduce government's role in our lives, it's a fair bet that government's share of the economy will be on a rising path for years to come. Frankly, to say that the world we knew on September 10th has "changed" may be an understatement.

One can process this information and postulate all sorts of scenarios about our economic future: more inflation; lower productivity growth; higher interest rates; trade protectionism; stagnation. All are possible. But then again, the Fed and Administration's response to the current situation has been very aggressive, including lower interest rates (the eighth and ninth this year) and massive government stimulus. In fact, no one really knows the net effect of these actions, and the future appears hazy. Remember: eighteen months ago few bothered to question the chorus of economists predicting that the New Economy would propel us all to higher and higher living standards; yet the foundation of that argument proved to be hollow, and the economy has sagged ever since. Macroeconomic forecasts are truly a dime a dozen and, as we've always cautioned, should be viewed skeptically. Yes, we are aware of the new risks our country and our economy face. But that doesn't mean that we've suddenly turned into geopolitical or macroeconomic theorists. The comfortable limit of our macro forecasting ability in the current day is this: the U.S. economy was weak before the terrorist aggression, and it is weaker today. As we argued three months ago, we're probably in a cyclical recession. In the meantime, it's not the end of the world. Period.

Our own focus for the past several weeks (as always) has been on the micro level: the effect on individual companies. Our primary goal is to understand whether and by how much the business value -- the intrinsic worth of the enterprise for its owners -- has changed, and whether the stock price accurately reflects that change. There have undoubtedly been sizeable impacts on a number of industries, including airlines, hotels, insurance, real estate and defense. Business has been interrupted in many cases, and significant shifts in supply and demand are affecting companies in these sectors. For some, the impact on business will last just a few days or weeks; for some, there may be a permanent change in the profitability of the business. Ultimately, we want to own companies where the stock is priced at a significant discount to intrinsic value.

Measuring levels of and changes in intrinsic value is necessarily an inexact science. Yet it is a crucial component of our research effort, particularly during times such as these where large changes can occur. Our analysts continually review fundamental company-specific information, including cash flow and discrete asset values, as well as qualitative assessments of franchise value. Ultimately, intrinsic value is representative of the discounted present value of the free cash flow the enterprise can generate over the long-term. So our focus extends over years, not weeks, and we try to avoid letting short-term cyclical or seasonal factors affect our long-term value estimates. For instance, a mild winter may have a short-term negative impact on snow blower sales, but over many years, one would expect the level of snowfall to follow some trend and for any one winter's snowfall to have a negligible effect on the intrinsic value of a snow blower manufacturer. In our experience, intrinsic values don't often change a great deal - they are fairly stable over the short run, and they tend to grow over time unless there is a significant secular change in the business.

Extrapolating from recent stock price movements, one would be tempted to say there have been significant declines in intrinsic value across most industries. Current stock prices seem to be suggesting there has been a permanent impairment in the franchise value and cash flow-generating ability of business. Many businesses are suffering right now, and some will likely suffer for quite some time. But over the longer term (2-4 years), we would argue that the impact on intrinsic value for many businesses is quite small. In our opinion, too many investors are confusing short-term problems with long-term trends. In such situations (a large stock price decline but no diminution in business value) we are finding some great buying opportunities. Conversely, we are sellers of stocks where the stock price has held up much better than has our estimate of intrinsic value.

Just to be perfectly clear, we are not taking a head-in-the-sand approach to the current environment. We are, in fact, factoring into our models significant profit changes for a wide variety of businesses, and this does impact our estimates of intrinsic value. But the market's sharp reaction has created some great opportunities to own strong companies at significant discounts to true business value. While near-term challenges will require patience, the only macro assumption we make is that the cyclical downturn in our economy will ultimately reverse. We could be wrong, but the historical odds are heavily in our favor. Note that the last secular downturn in the U.S. economy was the Great Depression, and fiscal and monetary prescriptions have advanced a great deal in the past seventy years. Furthermore, wars have usually proved to be more a stimulant than a depressant for the economy as a whole. Finally, the fiscal stimulus being discussed in Washington D.C. is likely to be unprecedented in size and scope. In any case, the market's broad negative reaction to recent events appears excessive, and as in similar situations, we believe there are some unique opportunities available for our clients. To bet against economic recovery and sell stocks today -- particularly after prices have fallen -- makes little sense for a long-term investor.

The world has changed...and yet it has not changed. The events of September 11th shake our sense of security and set the stage for an extended campaign against an unpredictable and ruthless foe. Government's role in the economy will surely increase, and we will be asked to obey new restrictions and sacrifice certain freedoms. But in many ways, our world remains as it was: our economy will experience ups and downs, company profits will fluctuate, and the intrinsic value of businesses will be based on fundamental characteristics which we will continue to evaluate. Most importantly, what has not changed is the market's tendency to confuse short-term, cyclical risks with long-term values, and this confusion breeds misguided action and panic on the part of many investors. While much of the market still appears uninteresting to us (just as it was before the attacks), more bargains appear each day. A worst-case scenario for our country and our economy is certainly plausible, but our experience and judgement -- developed over a quarter century -- argue it is a very low probability outcome. We have adjusted our expectations and valuation models where appropriate, and we have remained intensely focused on identifying in the stock market both opportunity and overvaluation. This discipline, we firmly believe, will continue to serve our clients well during this emotionally troubled period, as it has in the past.