The Markets and Terrorism

My heart goes out to all those directly affected by today's events in London. Terrorism is an evil that this world will defeat as time goes by, but only by teaching the world's citizens not to hate, but to embrace differences. We indeed have a long way to go.

Now, the point of this post is to discuss what happens to markets when events like this strike. So we will look at the last three major terrorist events: 9/11, the bombing in Madrid, and today's events.

As Jim Cramer said today on his "Mad Money" show, no one ever made a dime by panicking. While I am not the biggest Cramer fan when it comes to stocks, he is right here. Panicking can only lead to financial loss.

So, the question is, what is one to do when the world gets horrible news? This morning, on my ride to work, the morning show mentioned news of a terrorist attack in London, AND that the FTSE was down. Now, since this is a comedy-based morning show, I know there's something big when they mention that the financial markets are getting crushed. Chart of FTSE

Indeed, U.S. futures were also down. I remember hearing that the DOW futures were down 136 points. I usually get excited if they're up or down about 40 points in either direction! 136 is big movement.

And that's about the time when I said to myself, if I were home to daytrade, I'd be loading the boat with index funds. I'd be buying the SPY like nobody's business, and I'd be dumping them soon, if not today.

Why in the world would I do such a thing? Let's look at a chart of the S&P 500 a few years ago when 9/11 struck. Notice that this time it took a few days for the rebound to occur but you'll notice the index snapped back, very strong and for quite a while.

How about when the Madrid rail bomb went off on March 11th, 2004? Let's look at a chartof the Spain index.

Notice how in both cases, there was some selloff where stocks declined very rapidly, then almost immediately snapped back as the news was absorbed.

The point here is that markets react quickly and violently in what appears to me to be overreaction. It's only human nature. Not only that, but the pattern seems to be similar here. This is yet another example of human nature controlling the markets more than academic valuation models.