Where Terror Hurts Less


By David Wyss The July 7 terror attack in London has brought worries about terrorism's impact on the economy and financial markets to the fore once again. The losses, both financial and personal, trigger memories of September 11's devastating blow to Wall Street and remind investors everywhere that the war on terror is far from over. Yet while the impact of personal losses can hardly be overstated, the financial consequences of these one-time events tend to be small and fleeting.

In retrospect, even the September 11 attacks, when U.S. financial markets were closed for several days and thousands perished in the collapse of the Twin Towers, had only a modest impact on the economy and the stock market. Of course, this analysis ignores other developments that may have affected the markets at the same time, but the past suggests the London attack will only have brief repercussions for the economy and financial markets.

ALL TOO FAMILIAR. Certainly, the initial response following the London blasts was noticeable, with European markets down 3% and U.S. futures off 2%. However, by the close of trading most European markets had regained about half their losses, and the U.S. was back to no change on the day. Bond prices rose on the initial flight to safety but had given back about half their gains by the close.

The rebound was quicker than in recent similar episodes, which suggests investors are getting more experienced, unfortunately, at dealing with these types of crises. This is the third major terror attack of this nature on a Western city, and the impact on the stock market has been diminishing steadily. After September 11, the U.S. market -- as measured by the Standard & Poor's 500-stock index -- plummeted 4.9% on the next day of trading (admittedly, a week after the event, because the stock exchanges were closed at first). After the March, 2004, Madrid bombings, the S&P 500 fell 1.5%. After this most recent event on July 7, it actually closed higher.

The potential economic repercussion of these events is also overstated. Often, the hit occurs in the quarter the event happened or the following quarter. But within a year, real gross domestic product is usually up, often strongly. Even after the World Trade Center and Pentagon attacks in 2001, the economy -- measured by real GDP -- dropped only in the third quarter (and September 11 was pretty much the end of the third quarter anyway), was up a modest 1.6% in the fourth, and saw an increase of 2.5% a year later.

SNAP BACK. A look at seven major unexpected events from 1962 to 2004 shows that in general, the impact on GDP was small and temporary. Only when there was a longer-term effect on oil prices, as after the embargo by OPEC in 1973 or the 1991 Gulf War, was the economy still down a year later.

The only exception is the Reagan assassination attempt, but I think most analysts would agree that the shooting had little to do with the 1981-82 recession. I'm not sure the averages mean much here, but the individual events show little pattern, and that's the point.

Impact of Past Unexpected Crises on Real GDP (% change, annual rate)

Event

Date

Quarter of Event

Quarter after Event

Four Quarters after Event

London subway bombings

July 7, 2005

E3.8

E2.9

E3.2

Madrid train bombings

March 11, 2004

4.5

3.3

3.7

World Trade Center attacks

September 11, 2001

-1.4

1.6

2.5

Iraq's invasion of Kuwait

August 2, 1990

0.0

-3.0

-0.1

Reagan assassination attempt

March 30, 1981

8.4

-3.1

-2.5

OPEC oil embargo

October 17, 1973

3.9

-3.4

-1.9

Kennedy assassination

November 22, 1963

3.2

9.3

5.1

Cuban missile crisis

October 22, 1962

1.0

5.3

5.3

Average

2.8

1.4

1.7

E = Estimated

Crises not related to terror attacks have had even more fleeting reverberations for the market. Looking at the same set of events (see table below), the market fell an average 2.2% the day of the crisis but hit bottom an average of only four days later and was back to its previous peak within three weeks (13 days). The longest period to recovery was after Iraq's 1990 invasion of Kuwait (30 days). The shortest was the two days the market took to rebound after President John F. Kennedy's 1963 assassination.

DAMAGING BY-PRODUCTS. The story of the stock market in the post-1973 embargo is a bit misleading, however. The market, measured by the S&P 500, regained its pre-embargo peak of 111.3 in 10 days, but except for that day, it didn't trade above that level until Jan. 22, 1980. The weakness was only indirectly related to the embargo. It was really caused by the higher oil prices that followed and the government's poor handling of the crisis.

Market-Shock Events and the S&P 500

Event

Market's Previous Close

One Day after Event

% Change

Bottom

Trading Days to Bottom

% Change

Days to Recover

London subway bombings

1,194.9

1,197.9

0.2

Madrid train bombings

1,140.6

1,123.9

-1.5

1094.0

10

-4.1

18

World Trade Center attacks

1,092.5

1,038.8

-4.9

965.8

5

-11.6

19

Iraqi invasion of Kuwait

355.5

351.5

-1.1

334.4

2

-5.9

30

Reagan assassination attempt

136.3

134.7

-1.2

134.7

1

-1.2

4

OPEC oil embargo

111.3

110.05

-1.1

109.2

6

-1.9

10

Kennedy assassination

71.62

69.61

-2.8

69.61

1

-2.8

2

Cuban missile crisis

54.96

53.49

-2.7

53.49

1

-2.7

5

Average

-2.2

4

-4.3

13

The look at the past is encouraging, since it suggests the impact of the London bombings are modest -- at least in the short term. However, the general tension caused by chronic terrorism can have a long-term negative impact on an economy, by reducing investment, diverting funds from production to protection, and causing individuals to lose time in travel and other activities. Still, the historical data show the amazing resiliency of humans and how well they can adjust to a higher level of tension, even over long periods of time. Wyss is chief economist for Standard & Poor's


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