Effects of Terrorism on the Financial Markets

No matter where it occurs or who perpetrates it, a terrorist attack elicits strong feelings of shock, confusion, fear and uncertainty. There’s no reason to suggest this doesn’t also extend to the financial markets and broader economy.

Terrorism – the use of violence and intimidation for political aims[1] – is one of the biggest threats facing civilized society. Foreign intervention and aggression in volatile countries, regional and national power vacuums and extreme political and religious ideologies have all combined to form a dangerous cocktail that is threatening to push the globe deeper into chaos. November 2015 alone has seen multiple terrorist attacks, including bombings in Lebanon, France, Mali and Tunisia. The Islamic State of Iraq and Syria (ISIS or ISIL) has claimed responsibility for all of the attacks and has threatened to expand its operations around the world.

Terrorism breeds uncertainty

The financial markets detest uncertainty. Investors do everything in their power to anticipate and assess events before they happen. Things like corporate earnings, central bank press releases and economic data are monitored closely to understand how an economy, financial system or underlying financial asset is performing. A terrorist attack undermines all of that by creating an environment driven by fear and emotions rather than sound market analysis.

Uncertainty typically leads to two outcomes, often simultaneously: stock markets decline and demand for safe haven assets rise. Simply put, a safe haven asset is any asset that is used to hedge against risk and uncertainty. The most popular examples of financial safe havens include gold, US Treasuries and currencies like the US dollar and Swiss franc.

Terrorism can lead to a market crash

In rare circumstances, a terrorist attack can lead to a market crash. The most prominent example is the September 11 terrorist attacks on the World Trade Center in New York City. The attacks caused the global stock markets to fall sharply and forced the New York Stock Exchange to shut down for one week. It resulted in approximately $40 billion in insurance losses, making it one of the largest insured events of all time.[2]

The US Federal Reserve was also compelled to add $100 billion in liquidity per day for three days following the attacks.[3] Commodities like gold and oil also spiked; the former because of safe-haven demand and the latter because of concerns that US intervention in the Middle East would disrupt global crude supplies.

September 11 had another economic impact: it boosted war funding by more than $1.6 trillion, causing an untold number of deaths in Afghanistan and Iraq following the US invasions in 2001 and 2003, respectively.[4]

Investors remain stoic following 11/15/15 Paris attack

As the threat of terrorism has expanded, investors have become very efficient in “pricing in” the impact of violence. The November 15 attack on Paris is a good example of this. Although European stock markets opened on a weaker note the following Monday after the attacks, the losses were fairly modest. Even France’s benchmark CAC 40 Index was never down more than 2% in the first session after the attack[5] and would fully recoup its loss toward the end of the week.

By comparison, the bombings in Beirut, Mali and Tunisia barely dented investor sentiment. Saudi Arabia’s 2015 assault on Yemen has also been largely ignored except when investors feared a disruption in crude oil supplies. Let’s also not forget that the latest bull market in world stocks has occurred during the Syria war, one of the worst humanitarian crises in the 21^st century.

That investors have learned to operate efficiently following an unexpected terrorist attack was documented in a 2005 study by Dr. Les Coleman. Dr. Coleman, who studied nine Al Qaeda attacks from 1998 to 2005 concluded that:

“Only four bombings moved a major stock market by more than 1% within 90 minutes of their occurrence, on the four occasions when this occurred the first market reaction occurred within 20-40 minutes and was largely completed within another hour.”

He added, “This suggests that markets are very efficient in quantifying the financial impacts of terrorists’ events, and matches other evidence that markets take well under a trading day to price in completely unanticipated impacts.”[6]

Terrorism in perspective

Unlike the human toll, the financial impact of a terrorist attack can be quantified and mitigated against with the right investment strategy.[7] Unfortunately, terrorism (whether state-led, state-sponsored, sub-state or individual) has proven to be an effective strategy for silencing opponents, destroying societies and creating fear. This is why it is likely to remain in the foreground for the foreseeable future. It’s up to us as individuals to raise awareness, bridge our differences and not let the interests of a few politically motivated actors divide us.

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This article is a guest blog written by easy-forex