September 13, 2006

Is There a “Terror Discount” Built Into the Stock Market?

Filed under: Economy,Taxes & Government — Tom @ 2:18 pm

Jim Glassman thinks so, and says so in the October issue of Kiplinger Personal Finance. Unfortunately, I don’t have a link even for subscribers, as I’m in the process of converting my subscription from print to digital. Here are his money paragraphs:

The markets fear the worst, and those fears ar reflected — or discounted — in stock prices. In other words, 9/11 lives on — in the diminished value of every share of stock that’s traded globally.

Of course, I can’t prove that the “terror discount exists, but the signs are unmistakable. If the discount did NOT exist, then an event like the London subway bombings of July 7, 2005 would have clobbered stock prices in Great Britain and the US. (But they didn’t — Ed.)

….. You might think that after five years without a terrorist attack on US soil, investors might demand a smaller geopolitical discount from stocks. But as Prudential strategist Ed Keon once said, the fear of conflict has historically been worse for stocks than conflct itself. For example, although the stock market fell in calendar years 1939, 1940, and 1941, as Pearl Harbor approached, the period between the attack and 1945 was the best ever until the 1990s.

I would add two corollaries to what Glassman said:

  • The market of the 1990s, after the First Gulf War, took off as it did not only because of the dot-com silliness, but at least partially because it, like everyone but a few in and out of the government, underestimated the impact of the building terror threat.
  • Second, the markets had a great run from Feb. ’03 to Jan. ’04, with the Dow going from about 7900 to about 10600) because of the investment-related tax cuts (of course), but also because there was a sense (naive in retrospect) that victory in Iraq would critically weaken worldwide terrorist ambitions. It will take a sense that the threat is greatly and permanently diminished, or perhaps a new round of denial, depending on real circumstances on the ground, to get the markets going upward at a double-digit clip again.
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