On September 10, 2001, the Dow Jones Industrial Average (DJIA) closed at 9,605.51. In the aftermath of the September 11 terrorist attacks, the market reopened on September 17, 2001, and hit an intraday low of 8,755.46. The market would not recover for a month.
The September 11 incident is one of the most extreme examples of what terrorist activity can do to markets and individual stocks. The major attack was a few blocks from the New York Stock Exchange and the floor had to be shut down because of the damage to southern Manhattan. But terrorism attacks do not have to take place in major financial centers (like New York, London or Tokyo) to harm market confidence and stock prices. In this article, we'll show you how acts of terror can affect your portfolio and how you can protect your finances against future attacks.
Who Is Targeted?
Terrorist activities tend to target strategic assets, like oil fields and financial institutions. To this day, most major banks and brokerage headquarters in New York and London have substantial security to prevent these types of attacks.
However, banks and big oil companies are not the only firms that can feel the impact of terrorist activity. A study by OhioStateUniversity entitled "Terrorism and the Stock Market" (2005) identified 75 terrorist-related attacks on specific companies and found that the average loss per firm (per attack) was $401 million in market capitalization.
Reacting To Terror
Reaction to terrorist attacks is often more emotional than fact-based. While a brief interruption in the supply of oil from Iraq is not likely to raise world oil prices in any significant manner, rumors or threats of attacks can cause the price of oil to suddenly spike as people fear the worst. After a weekend attack on foreigners visiting Saudi Arabia in 2004, crude oil futures prices rose $2.50 the next day, according to The Washington Post article, "Oil Prices Reach New Peak As Terrorism Anxieties Jump" (2004). (To learn more about the oil industry, see Oil And Gas Industry Primer, Getting A Grip On The Cost Of Gas and Fueling Futures In The Energy Market.)
The rising price of oil often leads to concerns that prices of oil-related industries like airlines and car companies will rise, and the effect can spill over into the stock prices of these firms. (To read more about this subject, see Is That Airline Ready For Lift-Off?)
Because terrorist attacks are often viewed as having their largest impact on oil and the operations of financial institutions, investors who are concerned about this should make certain that their portfolios are diversified accordingly. A portfolio with nothing but shares in major car companies, airlines and other oil-and-gas-related companies is likely to be most affected by terrorist activities or rumors. (Learn how to diversify your portfolio properly in The Importance Of Diversification, Introduction To Diversification and A Guide To Portfolio Construction.)
A Closer Look at Target Stocks
These industries are most likely to see stock price movements due to terrorist activity, so let's delve into each one:
- Oil and Gas Companies. While the interruption of oil supply can be a threat to the revenue and profits of big oil companies like Exxon Mobil (NYSE:XOM) and ConocoPhillips (NYSE:COP), if the concern does not materialize into a long drop in supply, the law of supply and demand may still drive the price of oil up. So, these companies are hurt by long-term interruptions in supply but may be helped by increases in the price of oil as a result of demand.
- Airlines. As the September 11 attacks showed, airline shares can be nearly ruined by activity that hurts public confidence in flying and/or drives up the price of jet fuel. Long interruptions could even lead to more Chapter 11 filings in an industry that is already troubled by high labor costs and poor balance sheets.
- Auto Industry. Given the losses suffered by the U.S.-based car companies over the last two years, Detroit is highly sensitive to the price of fuel. Higher gas prices drive buyers away from SUVs and pickups, which are often the most profitable vehicles for car companies.
- Exchange and Bank Stocks. Any attack that cripples the financial infrastructure, either by shutting down internet and telecommunications or by physically closing an exchange, would make shares in these companies vulnerable.
There are some stocks that could be considered safe havens if investors are concerned about terrorism and its impact on share prices. Obviously, security shares that cover IT infrastructure are likely to do well, as are companies that provide physical security at locations like airports.
Defense stocks - companies that manufacture things such as weapons, ammunition and fighter jets - also tend to react well to fears about terrorist issues.
Adding defense and security stocks to a portfolio to protect investors who have concerns about terrorism may be a good move, and many of these stocks hold up well on their own, too. They may be good investments even in an environment where terrorism is not an issue.
Setting Your Stops
Another tactic for investors concerned about terrorism issues is putting stop-losses on shares that may be vulnerable to sharp drops in the event of attacks on the global physical or information infrastructure. These stops would pull you out the stock - hopefully before you lose a great deal of money. (To learn how to make your stop-loss orders, see The Stop-Loss Order - Make Sure You Use It and How does a stop-loss order work?)
While there is no perfect strategy for hedging against terrorism in a portfolio, there are stocks that are less likely to be hurt if the market is rocked by an attack. Also, there are methods for making sure that shares are sold if they drop by more than an investor is willing to risk. Make sure you know where your portfolio sits in this ever-changing world so that if the worst happens, your finances will be prepared - even if the world isn't.