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The past two months have been fraught with shocking acts of violence: from Thursday's truck attack in Nice on Bastille Day that killed at least 84 people; to the ISIS truck bombing in Baghdad that killed nearly 300 earlier this month; to the July attack at Istanbul's airport that killed 41; to the deadliest shooting in U.S. history in Orlando in June, which killed 49 and injured at least 53 at the Pulse nightclub.
Add to those episodes two police shootings, the first in Dallas two weeks ago, and the second Sunday morning in Baton Rouge.
Obviously, your investments aren't the first thing on your mind when such horrific events occur. But it’s natural to wonder if the rising threat of terrorism, or the latest police shooting, could have a ripple effect on the fragile economy — or if the next episode might set off a panic in the market.
Should you prepare your portfolio, defensively, just in case?
History says not to expect a terror-related meltdown. Over the past 35 years, no act of terrorism has ever driven stocks into a bear market (meaning a 20% drop) or even a prolonged downturn. “Remarkably, even the tragedy of 9/11 didn’t leave long-lasting damage in the stock market,” notes Jack Ablin, chief investment officer at BMO Private Bank.
Unfortunately, “we have many terrorist attacks in recent history to look at for a sense of how stocks might react,” notes Burt White, chief investment officer for LPL Financial. But at least “the data are encouraging,” he says.
Ned Davis Research studied the market’s reaction to 23 large-scale acts of global terrorism since the late 1970s, from the 1983 attack on Marine barracks in Beirut to the 2005 London train bombings. Three-quarters of the time, the Dow Jones industrial average was up within a month of the event.
In all but one case in which equities didn’t snap back quickly — a bombing in India during the global financial panic — stocks had recovered and were back in positive territory within six months.
And neither the Dow nor the S&P500 reacted dramatically to the Nice attack.
Why is the market so resilient?
It’s not that investors have been especially brave. Rather, a terrorist event is one kind of bad news that you can count on the Federal Reserve and other key central banks to respond to.
Just days after 9/11, for instance, the Federal Reserve cut short-term borrowing rates from 3.5% to 3% to shore up the economy. As it turned out, the U.S. economy was already in recession, but policymakers did not know that at the time. So the Fed kept cutting rates aggressively for the next 12 months, which may have helped the U.S. exit its recession by the end of 2001.
Similarly, weeks after the November terrorist attacks in Paris, the European Central Bank cut interest rates and extended its stimulative bond-buying program.
Major rate cuts aren't expected this time around, as global interest rates are already near zero — or in some cases, like in Germany, below zero.
But terror threats — along with anything that may hurt the global economy — are likely to be one reason the Federal Reserve leaves interest rates low for a while. In fact, many investors now believe the Fed is unlikely to raise interest rates for the rest of this year.
What else should you look for?
While the terror risk is not a reason to be scaling back on long-term equity investments, distressing news can set off a wave of short-run volatility. The CBOE Volatility Index shot above 40 — double its normal level — just days after 9/11. The same so-called Fear Index also spiked after the U.S. embassy bombings in Africa in the summer of 1998.
After the Nice attack on Thursday, the CBOE VIX index jumped, but only managed to climb above a reading of 13, which is still much lower than it was in the aftermath of Britain's Brexit vote.
Of course, that could change in the days ahead.
But if you are already preparing for the greater volatility that comes in the late stage of the bull market (see Is it Time to Get Ready for a Bear), you won’t have to add investments to your worries if or when more trouble comes.