Today's Headlines: Are We Economically Desensitized To Terrorism?

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Today's Headlines: Are We Economically Desensitized To Terrorism?
March 29, 2016

Terrorist Attacks and Stock Markets

Europe suffered another orchestrated terror attack last week as suicide bombers simultaneously attacked the airport and mass transit systems in Brussels, Belgium — the capital and nerve center of the European Union. With this fresh attack coming on the heels of the November 2015 Paris attacks that had Belgian connections, the small nation’s resilience is being tested as never before. Authorities remain on high alert for follow-up attacks.

Belgium's tourism industry, having just begun to recover from the Paris attacks, suffered another major setback. The Chelton Hotel across from the EU headquarters lost 35% of its revenue after the November attacks, and management fears that it will take significantly longer to recover after a direct attack on their hometown.

However, while local economies struggle to recover from these horrific attacks, the effect on larger financial markets appears to be fleeting. Scott Brown, Chief Economist at Raymond James, sums it up this way: "Sad to say, but the financial markets may have become desensitized to terrorist attacks."

The Resilience of Broad Markets

Stock market reactions to the Brussels attacks suggest that James may be correct. Not only did the US stock exchanges finish essentially flat on the day of the attacks, but Germany's DAX and Great Britain's FTSE 100 also recovered for the day after an early dip. Perhaps the largest impact of the day was indirect: the British pound fell significantly on the assumption that public opinion regarding the attacks makes a British exit from the EU more likely.

Other research backs up this assessment. Charles Schwab Chief Global Investment Strategist Jeffrey Kleintop compiled information on worldwide market reactions to terrorist attacks over the last 45 years, from the 1972 Munich Olympic bombing to November's Paris attacks, and analyzed the average number of weeks it took the host country's stock market to recover from the event. The average return was 2.8 weeks, and that number was greatly skewed by two values: the 1990 London Exchange bombing at 33 weeks and the 1998 US embassy bombings in Kenya and Tanzania that required 12 weeks for the market to recover. As catastrophic and far-reaching as the 9/11 attacks on New York City were, stocks only required 4 weeks to recover from a 12% drop in the first five post-attack trading days. Of the 26 attacks studied by Kleintop, stocks recovered within the same week 14 times.

Some industries Suffer, Others Gain

Broad markets may shrug off terrorist attacks, but certain industries are disproportionately affected. The travel industry, for example, typically sags after an attack and the Brussels attack was no exception. Air France (EPA: AF) dropped by almost 5% immediately after the attack. American (NASDAQ: AAL) and Delta Airlines (NYSE:DAL) fell 1.1% and 1.6% respectively. All three airlines' stock remains down as of this writing.

It's not just airlines that suffer. Priceline (NASDAQ: PCLN) and Expedia (NASDAQ: EXPE) fell 2.5% and 1.4% respectively on the day of the attacks. Even cruise lines were affected, with Royal Caribbean (NYSE: RCL) down 3.1% and Carnival (NYSE: CCL) down 2.5%.

These industries will eventually recover, as will retail businesses in the affected area, despite the negative short-term impact. The Economist pointed out that after the Paris attacks consumers tended to only delay trips or purchases instead of cancelling them entirely. However, it remains to be seen whether an increased frequency of attacks will alter this perception and lengthen recovery time. Strangely, it could induce a shorter recovery time should residents accept that this is the way life is now — much as war-torn areas of the Middle East have done for years.

Who gains stock value from terrorist attacks? Defense-related industries often prosper in the short term. The Monday after the Paris attacks, the stock of defense contractor Raytheon (NYSE: RTN, the provider of Tomahawk missiles) shot up 4%. Lockheed Martin (NYSE: LMT) rose by 3.5% and Northrop Grumman (NYSE: NOC) also posted gains. Even AeroVironment (NASDAQ: AVAV), a drone manufacturer, saw a 6% rise in stock on the anticipation of greater use of drones against ISIS.

Such gains are not surprising, in light of severe, post-bombing reactions from several western leaders, including French President François Hollande, who pledged, "Terrorism will not destroy France, because we will destroy it." As of this writing, all of the above defense stocks retained their surge and are generally staying around their new higher benchmark.

Stocks of macro-scale defense companies often rise with terrorist attacks but those on the micro scale do not always follow suit. For example, gun manufacturers Smith & Wesson (NASDAQ: SWHC) and Sturm, Ruger & Company (NYSE: RGR) stayed fairly flat after the Brussels attacks and both fell sharply on Friday.

Gun stocks tend to rise not in response to terrorist attacks but instead with governmental follow-up responses — particularly in the US whenever the administration repeats requests for gun control after a mass shooting. After President Obama's prime time speech in December, Smith and Wesson and Ruger climbed 8% and 6% the next day based on the typical (and never-realized) fears that gun restrictions are imminent.

Long-Term Concerns

Terrorism could have longer-term, so-called "secondary effects" on the world economy that can have profound economic consequences, but are difficult to tie directly into economic data. Britain's potential exit from the EU (aka the "Brexit") is one such example. Another is political fallout that can encourage isolationism and discourage free-trade policies. These tendencies can damage economic growth, despite the populist argument otherwise (see Trump, Donald, among others).

Add a layer of security concerns that stifle immigration and the free flow of people and goods, and the effect can be devastating — especially to more fragile economies. One study from 2013 found that smaller (by GDP) trading partners of larger economies hit by terror attacks see an average loss of 2.5% in their stock indices. These smaller economies are 5.7 times more likely to experience a "negative abnormal stock impact" as compared to other countries. Presumably smaller trading partners tend to have limited leverage to counteract a detrimental trade policy of a larger trading partner.

The Takeaway

Markets hate uncertainty more than just about anything else — and unfortunately, we have reached a point where periodic terrorist events are now expected. As a result, such events may be risk-priced into typically affected industries (either consciously or sub-consciously). The pace and timing may change, but history tells us that terrorist attacks will almost certainly continue. History also tells us that our financial systems should remain resilient to these attacks.

A greater concern may well be with cyber attacks: the potential future of terrorism. Our financial system and infrastructure are increasingly electronic in nature. Should terrorists successfully pull off a large-scale assault on our information systems and freeze up financial systems or shut down utilities, the corresponding lack of confidence could pose a new and longer-lasting shock to financial markets. Fortunately, our collective defenses against such cyber attacks have prevented catastrophic attacks so far. Whether we remain so fortunate in the future remains to be seen.

As a final note, we should add that when terrorists strike, it is not our first instinct to worry about our investments — nor should it be. If we ever reach that point as a society, we are in deep trouble indeed.

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Steffanie | 03.30.16 @ 16:02
This is a great point of view. I never thought of how the attacks effect the economy in this way. Desensitized is unfortunately a good way to describe it.
Erin | 03.30.16 @ 16:04
It doesn't surprise me that travel industries take a hit financially after an attack, but they've become so common, unfortunately, that I think it has become a new normal, and it doesn't affect all industries the same way it used to.
Nancy | 03.30.16 @ 16:04
Interesting. I have never really paid attention to the effects that terrorism might have on our financial markets. It's something to watch in the future.
Brittany | 03.30.16 @ 16:04
I think it's coming to a point where it's happening more and more often, that while, yes people obviously care about the loss of life that happens in these attacks, it's almost like... it's expected at this point.
Carla | 03.30.16 @ 16:04
I had never thought of the economic impact of these tragedies. I have a feeling the hits are going to keep coming unfortunately.
Sarah | 03.30.16 @ 16:05
Of course we are! It's too far away to worry with. Just pick your phone back up and keep taking selfies, it'll be fine....
irene | 03.30.16 @ 16:05
Wow that's an interesting take on the situation
Kailie | 03.30.16 @ 16:06
This I can understand, that certain industries would tend to take a hit in the mists of an attack, especially traveling, when it comes to attacks like the one in Brussles, since it happened AT an airport, it makes people a little more cautious. Great article.
Christina | 03.30.16 @ 16:06
Its sad that we would have to worry about all this. Terrorists will hit where it hurts the most.
trish | 03.30.16 @ 16:06
This article hits on all the points we have discussed as a family. No surprise travel companies have been affected due to fear. And the fact that we as a nation are becoming less and less shocked to hear of acts terrorism makes my heart hurt tremendously.
Jo Ann | 03.30.16 @ 16:12
This is very interesting about the effects terrorism has on the markets. It seems that our economy does get influenced by what is going on in the world. I think that we have gotten use to the new so called NORMAL of random acts of terror. So as terrorist attacks become more and more likely the economy will possibly recover quicker after the attacks.
$commenter.renderDisplayableName() | 10.31.20 @ 01:53