Looking back: Five years laterEconomists examine market's response to terrorism

The dismal science confronts dismal events. Economists agree that terrorism hurts the economy. Businesses are destroyed, investment resources are detoured to security operations, supply lines are disrupted, and stock prices drop as forward-looking investors worry about more of it all in the future. This is all very predictable. What experts are less sure of is how the market reacts to terrorist acts that have occured some time in the past and those that have not yet materialized. The conventional wisdom is that the terrorist risk is built into stock and commodities prices, but by how much?

David Sowerby, chief market analyst, Loomis, Sayles & Co., estimates that the threat of terrorism represents a 5 percent ”tether” on stocks. The overhang is ”more than zero, less than ten. Five seems reasonable. If I said four, I’d be fine-tuning it too much,” he said. Sowerby’s estimate is confirmed by an understated price to earning ratio on the S&P 500. Now at approximatly seventeen, traditional models would expect it to be closer to twenty. Some analysts, however, warn against taking these numbers too seriously. “People keep saying there’s a war premium in the price of oil,” said Robert Streed, portfolio manager of Northern Trust Select Equity Fund in Chicago. ”People keep throwing out numbers, but I can’t see any objective way they come up with those numbers.”

They keep trying, though. One interesting study comes from Andrew Chen of Southern Methodist University and Thomas Siems of the Federal Reserve Bank of Dallas. They tracked the Dow Jones industrial average’s recovery time from such disparate events as the sinking of the Lusitania during the First World War, Hitler’s invasion of France, and the 9/11 attacks. While the market took 795 days to recover from the invasion of France, the Dow actually rose on the day of the Oklahoma City bombing attacks. “They theorize that faster communication and broader market participation has led to faster stock rebounds,” AP reported. More recently, the market remained strong after the discovery of the liquid bombing plot in Britain. Aside from communication and market participation, the maginitude of the threat seems to a be a critical element. The Second World War and 9/11 threatened almost every sector of the economy. The attack on Okalahoma City, on the other hand, while tragic remained a locally contained disaster.

-read more in this AP analysis