The 9/11 Effect

Why financial markets reacted as they did.

A Frankfurt trader reacts to the London news

Talking about a market session in the middle of it is like writing the story about a baseball game in the fourth inning. And the scale of the 7/7 attacks is much smaller and in many ways fundamentally different than the 9/11 attacks; trading never stopped on the London exchanges and New York trading opened on schedule. Still, it’s worth noting that the early market reaction to the London bombings shows some striking similarities to the reaction to Sept. 11.

Markets have a lot of muscle memory. And when traders and investors react to crises that crop up, they instinctively and perhaps subconsciously fall back on knowledge and experience. Just as generals always fight the last war, traders grappling with a coordinated terrorist attack on a global financial center to a degree are trading the last event. Today, in the markets in London and New York, we’re seeing the lessons of the post-9/11 investment fallout being applied in real time.

Overall today, stocks fell, but not by much—especially given the gravity of the attacks. London’s benchmark FTSE 100 index fell by nearly 4 percent, but quickly bounced back and closed down a mere 1.56 percent. In the United States, the Dow Jones Industrial Average opened down 93 points, or less than 1 percent, and then muddled along as it tends to in a typical lame summer session. By noon, the markets had rallied to near break-even. With this muted reaction, traders could be taking a cue from the post-9/11 action. At first, those attacks, which took out the headquarters of many financial firms and caused the New York Stock Exchange to shut down for a week, seemed to inflict a grievous blow. In the first four days of trading after 9/11—the New York Stock Exchange didn’t open again until Sept. 17—the Dow fell 14 percent. But Wall Street recovered rapidly, and the effects turned out to be temporary. Within a few weeks of trading, the markets regained all the ground they lost. And it turned out that the post-9/11 selling frenzy was a good time to buy broad indexes both for the short term and for the long term. The Dow today stands nearly 25 percent higher than its post-9/11 short-term nadir.

When the attacks came this morning, oil was pushing to new highs, perhaps spurred by a Financial Times front-page article that said OPEC “will be unable to meet western countries’ demand projection in 10-15 years.” In such an environment, a dramatic act of jihadist terrorism, which highlights Middle East instability, would be expected to push oil higher. Instead, oil fell sharply. Which seems strange. After all, the bombs knocked out the Tube but didn’t disrupt air travel at all, and shouldn’t have much immediate impact on global demand for oil. But again, the market’s muscle memory of 9/11 may be in play. After those attacks, travel ground to a halt, especially in the United States—the world’s largest consumer of fuel for jets, trucks, and cars. So even as Middle East instability rose after 9/11, the actual demand for oil fell off.

The groups of stocks hit the hardest when New York opened—travel and insurance—were the same ones that got hit hard after 9/11, even though no airplanes were hijacked, London’s Heathrow Airport remained open, and there was no evidence of the type of the massive damage to private property that can cause insurers to take big hits. U.S. retailers were among the stock sectors that slumped at first, which seems strange. After all, many, including Wal-Mart and Costco, had just reported excellent June sales. Perhaps traders had in the backs of their minds one of the more unlikely initial reactions to 9/11. Shopping ground to a halt as people stayed home to watch the news on television. After an initial spike, Wal-Mart, in the week of Sept. 11, saw a slowdown in traffic due to what it dubbed the CNN effect. And in September 2001, retail sales fell almost 2 percent from August 2001.

Forecasting by analogy is always dangerous, because no two markets or crises are ever directly comparable. And terrorism derives its impact in part because the timing and location of attacks are almost by definition unexpected. It’s clear that the knowledge of what happened on Sept. 11 couldn’t forestall today’s attacks on London. But it seems that the knowledge of what happened in the markets after Sept. 11 may be playing a role in making the market reaction to the attacks of July 7 calmer and less dislocating.