On Monday, September 17, the New York Stock Exchange opened for the first time since the horrific attack on the World Trade Center. Predictably, the market sold off, but did so in a quite contained fashion as the S&P 500 closed down only 4.9%. We consider the orderly market and limited decline very encouraging. In attempting to gauge the market’s future course, it’s instructive to look at the history of the market’s reaction to previous external, non-economic shocks.
As reported in Barron’s yesterday, Ned Davis Research has reviewed 28 instances of the market’s reaction to such non-economic shocks dating back to the fall of France in 1940 and including Pearl Harbor, JFK’s assassination, the Cuban Missile Crisis, the Gulf War and the 1993 bombing of the World Trade Center. In each case the market sold-off initially, with an average decline of 7.1%. The point to underline is that on average it took only one month for the market to fully recover from these sell-offs.
On average, three months after the event the market was up 6.8%–that is, up 6.8% after fully recovering from the decline. Six months later the market was on average up 12.5%. While past may not be prologue, this historical pattern fits our understanding of the way that market psychology tends to work.
The market–like nature–abhors a void. Whenever a frightening uncertainty grips the market, investors project their worst fears into the void created by that uncertainty. Having terrified themselves with the sight of their own projections, they sell, driving down stock prices. As some visibility develops on the future course of events, the market historically has recovered and has done so for one simple reason: investors can cope with actual outcomes, whatever they may be. It’s uncertainty they find so profoundly unnerving.
As our country and others clarify their responses to this heinous act, the market will regain its footing and begin to price shares rationally based upon economic realities. It is possible that the terrorist attack increased the odds of recession in the U.S., though that is by no means a foregone conclusion. Whatever the outcome, the market was already pricing in a weak economy. Thus any additional weakness brought on by the attack will be incremental relative to already low expectations.
Offsetting the economic negatives introduced by the attack are the positive responses of the Federal Government. The Federal Reserve is furiously pumping money into the economy by both direct market action and cutting the Fed Funds rate again yesterday by 0.5%. The Fed and central banks around the world are flooding the global system with liquidity, and there is no more powerful economic stimulus.
The other major policy response of the Federal Government will be to launch a wave of fiscal stimulus that will build rapidly. While the budget surplus has already been greatly reduced, the fact that there is any surplus at all affords the Federal Government a great deal of flexibility in its efforts to support the economy. Rebuilding infrastructure and bailing out airlines are but two of the most obvious pieces of the stimulus package. Together, Federal monetary and fiscal policies designed to stimulate the economy will serve as a powerful counterweight to any recessionary influence from the attack.
Sadly, it seems our country is at its best in times of crisis. I spent the last few days driving from Tucson back home to Durham, covering the better part of the coast-to-coast span. I ate in a lot of truck stops and stayed in a lot of motels. I found civility, diversity, humor, helpfulness and an expansiveness of spirit you have to call “heart.” I hope that spirit guides our leaders in their awesome deliberations. I hope they show the world that we as a nation are not only strong, but also wise.