The Markets’ initial
reaction to the attack in London reveals quite a few things about investor
psychology. It also shows us, to a small degree, the thought processes of
Terrorists.

Dow futures
plummeted to negative 220 (and worse) as soon as the news of a attack broke.
That suggests to us a few hair-triggered traders had assumed the worst. Their
bets essentially discounted the possibility of a minor assault. As that proved
to be the case, they reversed their short positions, and went long.

Markets’ initial
reactions tend to be proportional to body count (see NY/DC, Madrid,
London). Hence, short-term wash-out occurred as events unfolded: London turned
out to be a less horrific attack than Madrid. In effect, the wash-out turned
into a terror rally. But as we have noted, Markets have a tendency to
wobble, over-reacting one way and then the next. Afterwards, they revert to
their prior courses.

The reason for this
is simple – terror causes far less financial damage than does a good Hurricane.
And, the total loss of life from terror over the past decade doesn’t compare to
a year’s worth of auto accidents in the US. Once the initial adrenaline-charged
response subsides, you are left with a horrible event from a Human standpoint,
but a relatively insignificant one from an economic perspective.

Put the disruption
into context: consider the multi-trillion global economy, or the even larger
global capital markets. The economic damage simply doesn’t scale up to the
trillions and trillions of dollars global commerce generates.

This doesn’t imply
we should be complacent. Indeed, in the United States, there is a lot more we
can and should be doing to ensure that a catastrophic assault is as
close to impossible as we can make it. But the grim reality is that any maniac
can walk onto a subway or bus and blow it up. And as we’ve seen, the timing of
these assaults are during rush hour to maximize damage to soft targets
(civilians) and ensure media coverage. The daylight assaults generate dramatic
video footage, and the early morning timing all but guarantees front-page
headlines the next day.

Where does that leave investors as of right now? The markets were consolidating after the run up from the April lows. I would expect that process to continue, so as the terror related emotions fade, so too, might the markets. The thrust off of the 2005 bottom indicated an institutional change in attitude towards risk and equities.

That implies to us that a strong second half rally continues to be in the offing, barring any additional external events. Investors can use any weakness in July to accumulate long positions.

Category: Investing, Psychology, Trading, War/Defense

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One Response to “Terror Rally”

  1. Emmanuel says:

    With regard to the market’s reaction to the London attacks, I have two points to add:

    First, there’s something of a “thank goodness it didn’t happen here” feeling prevalent on the Street. I am wary of this reaction. Since one of the terrorists’ assumed objectives is to inflict as much chaos on global markets as possible, they might’ve been disappointed by how US bourses largely brushed off the London events. How do they then get the attention of complacent Americans? The answer is rather grim given their relative efficiency in creating chaos.

    Second, while terror doesn’t loom large in terms of casualties in the (ahem) big picture, consider its erstwhile effects. Such actions only guarantee further military adventurism worldwide by various governments. Spending hundreds of billions of dollars on “fighting terror” is a burden on the budget and means less spent on arguably more productive pursuits such as research and education. Consider also the backlash from such military adventurism. Many promising foreign markets are in predominantly Muslim nations. The crackdown on terror does no PR favors for America and its companies.

    Make no mistake. These events are neither a blip on the American radar nor a drop in the global bucket.