(AdvisorOne looks at seven days when the Dow plummeted because of an external disaster or, for various reasons, plummeted on its own, and what role human behavior played in moving markets, in a story that originally appeared in Investment Advisor magazine's July 2011 issue.)
Historically, Americans have always been an optimistic lot, but there have certainly been times when optimism has yielded to its darker sibling, pessimism. This is never more true than when disaster strikes. Do the financial markets view disasters as a friend or enemy? Does fear among the masses create opportunity for the few? Are the events to which we ascribe market behavior fact or fiction? And, can we really know for certain?
What really moves markets and how has the stock market reacted to unforeseen, catastrophic events? Moreover, how do financial statistics, which typically reflect past events, impact human—and hence, market—behavior?
U.S. DISASTERS
The effect that various disasters in the United States have had on stocks is influenced by multiple factors. For example, if the event levied a lofty price tag, but was localized and did not disrupt the "collective economic engine" to any significant degree, the market fallout was minimal. Moreover, if the economy was growing at the time of an event, momentum provided a helpful tailwind. Let's begin with WWII and the reason we entered the fray.
Pearl Harbor
It was near 70 degrees and partly cloudy in Honolulu on the morning of Sunday, Dec. 7, 1941. Just prior to 7:50 a.m.—the time when the Japanese pilots began their assault—many U.S. military personnel and their families lay fast asleep after a Saturday night on the town. The next day, FDR addressed Congress and uttered the famous phrase, "A date which will live in infamy." The United States was at war. In the wake of the attack, Pearl Harbor and America would never be the same.
The sad irony is that Americans held a strong "isolationist" belief at the time, and had it not been for the vicious assault on the U.S. naval base at Pearl, our introduction into WWII may have been delayed, perhaps even avoided.
For the 12 months prior to the attack, the average daily trading volume on the Dow Jones Industrial Average was about 560,000 shares. During the following three weeks, trading volume nearly tripled to 1.6 million shares per day. What was a bit surprising was its performance. With an event as serious as this, most would expect fear to reign and stocks to sell off with great fervor. Although stocks did decline, the rate of descent was far from severe. In fact, on the Friday before the attack, the DJIA had closed the day at 115.90. On the Monday after the attack, it lost 2.92%, closing at 111.53. On Tuesday, it fell to 107.56 for a loss of 2.89%. However, by the time Americans were singing "Auld Lang Syne," the DJIA stood at 110.96, down less than 4.0%. The following year it rose 7.6%.
With America's advent into the war, the economic engines began to hum. As factories retooled to manufacture tanks instead of trucks, planes instead of Pontiacs, the unemployment rate began to fall. The economy was on a path to recovery, and as corporate earnings grew, the stock market embarked on a 20-year binge.
Sept. 11, 2001
On Sept. 11, 2001, 19 al-Qaida terrorists commandeered four commercial passenger jets, set out to kill American citizens and crash the U.S. economy. Nearly 3,000 souls were lost that day in one of the most horrific events in recent history. This tragedy struck on the heels of a ruptured tech bubble and occurred during an already flagging economy. According to the National Bureau of Economic Research, the U.S. recession had officially begun six months earlier. After the second tower was struck, the stock market was closed, and remained closed for a week, as heroic volunteers sifted through the rubble hoping to find signs of life.
Already off 18% from its early 2000 peak, when the DJIA reopened the following Monday it fell an additional 7.13% and the bear market became official. The Dow continued to fall over the next four consecutive days, losing another 14.26% from its pre 9/11 close. All in all, investors were down nearly 30% from January of 2000. With the predictability of a sunrise, trading volume spiked. In fact, the DJIA traded two billion shares for the first time in its history on Sept. 17, 2001. Average daily trading volume increased 50% in the 12 months following the attack as compared to the year prior.
This disaster occurred in the midst of a recession and a declining stock market. As a result, its impact was more acute. However, after bottoming out on Oct. 9, 2002, the markets once again began to ascend. And by the time our next disaster rolled around, the market was well on its way to a complete recovery.
Hurricane Katrina
The two prior disasters were largely unforeseen. However, this particular lady was announced with thunderous pomp, as she sauntered toward the shores of Louisiana. Katrina was one of the deadliest hurricanes in the history of the United States, claiming nearly 2,000 lives, and was the most expensive, sporting a price tag of $45 billion according to the Insurance Institute.
Katrina occurred during a time when the U.S. economy was growing. Even with the infamous title of "Most Expensive Hurricane," Katrina is virtually undetectable on a stock chart, causing no more than a blip on the screen.
Although it was the most costly hurricane in U.S. history, its financial impact amounted to 0.35% of our nation's GDP. Considering that the economy was strong at the time, even the oil disruptions were tolerable.
FOREIGN DISASTERS
The Great Japan Earthquake of 2011
On March 11, 2011, just off the east coast of northern Japan, a horrific earthquake measuring 9.0 struck, claiming the lives of more than 15,000 people. This quake was estimated to be over 600 million times more powerful than the Hiroshima bomb. Only two days prior, on March 9, the area experienced four earthquakes in excess of 6.0 with one at 7.2. Following the quake there were more than 800 aftershocks of 4.5 or greater. The tsunamis that followed added an extra layer of grief to the quake and near meltdown of the area's nuclear power plants. How did the financial markets react?
October 28 and 29, 1929
