Friday, August 29, 2014

Who's afraid of the Big Bad Terrorist?

On Friday, the UK government raised its terror threat from "substantial" to "severe" as Home Secretary Theresa May warned of threats from jihadists from Iraq and Syria. Global stock markets sold off initially on the news, but recovered later in the day.

The answer is an emphatic "yes". As investors and traders, we should be focusing on fundamentals. Aside from the tragedy of injury and loss of lives, market participants should be asking what impact a terrorist attack would have on the growth outlook and interest rates. In most cases, the answer is "not very much."

Consider these three examples of how the market reacted to past terrorist events. Here is the market reaction to the Boston Marathon bombing. Blink and you would have missed the disruption.

Here is the market reaction of the FTSE 100 to the July 7 London bombings. Again, blink and you would have missed it.

Here is the market reaction to the Madrid train bombings of 2004. In this case, the story was a little complicated. Wikipedia explains the sequence of events this way:
The bombings occurred three days before general elections in which incumbent José María Aznar's PP was defeated. Immediately after the bombing, leaders of the PP claimed evidence indicating the Basque separatist organization, ETA (Euskadi Ta Askatasuna) was responsible for the bombings, while Islamist responsibility would have had the opposite effect as it would have been seen as a consequence of the PP government taking Spain into the Iraq War, a policy extremely unpopular with Spaniards.

Nationwide demonstrations and protests followed the attacks. The predominant view among political analysts is that the Aznar administration lost the general elections as a result of the handling and representation of the terrorist attacks, rather than because of the bombings per se.
In this case, the charts show that the markets were reacting to the news of the bombing and the election, which occurred on the weekend three days later:

The moral of the story: Don't just react to headlines, focus on fundamentals.

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