Why did stocks finish the day higher after Thursday’s tragic terrorist bombings in London? There are several very simple reasons. To begin with, the market wasn’t surprised. Ever since September 11, 2001, markets have been braced for terrorist attacks.
London knows as well as any city in the world what it’s like to live with the threat of terror. From 1981 to 1996, the Irish Republican Army carried out a series of bombings in public places in London ranging from small pubs to huge office buildings. Separately, government officials were kidnapped, beaten and murdered.
I remember doing business in London during those years. I remember the police checkpoints along the roads leading into The City — London’s equivalent of Wall Street — where cars were routinely searched for explosives. From 1981 to 1996 the value of the FTSE-100 Index — Britain’s equivalent of the Dow Jones Industrials Average — increased by a factor of eight. It turns out that it takes quite a lot to keep a robust economy from growing — and right now it looks like it will take a lot more than the terrorists have got.
And don’t underestimate the extent to which markets have already priced the worst. Yes, stocks recovered from their panic bottom right after the September 11 attacks, but they subsequently made lower lows, and valuations have never really been the same since. Let me illustrate.
Since September 2001, S&P 500 earnings have grown a remarkable 50%. But market capitalization has grown by only 18%. That means investors are getting those additional earnings at more than half-off, compared with 2001 prices. And remember, by September 2001 stocks were already well off their highs from the bubble in 1999 and 2000. When stocks are as cheap as they are now, it takes an awfully big shock to make them much cheaper.
Another reason why stocks rose on Thursday might be that tragedy has a way of bringing people together, and causing them to set aside their differences. Shortly after the attacks on Thursday, Congressional minority leaders Harry Reid and Nancy Pelosi both issued statements expressing solidarity with President Bush and Prime Minister Blair.
On an ordinary day, Reid and Pelosi would have found some reason to issue statements condemning Bush for something or other. Fine — that’s their job. But in today’s bitter and divisive political climate, a little political comity only be to the good. It’s hard for an economy to work at full potential when a nation’s leaders spend all their time trying to destroy each other.
This particular moment is an especially good one to have a little break in the normal level of political viciousness. That’s because there is the potential now to build on some very positive political developments that had already been set in motion over the last couple of weeks.
The most important development is that the legislative wildfire to impose protectionist tariffs against China has pretty much gone out. In May I warned readers about the bill introduced by Senators Charles Schumer (D-N.Y.) and Lindsey Graham (R-S.C.) to slap a 27.5% across-the-board tax on all Chinese goods. That would have been a death-blow to Walmart and American consumers — and it’s great news that Schumer and Graham have decided to withdraw the bill.
The idea of the bill was to force China into letting its currency — the yuan — float freely on world markets, as opposed to keeping its price fixed relative to the US dollar, as it is today. The hope was that a floating yuan would appreciate in value, making American goods more competitive on world markets vs. Chinese goods. Last week China officially announced that it will float the yuan at some unknown point in the future, and that’s been enough to get Schumer and Graham to back off.
Quite a relief. Never forget: It was a tariff bill that triggered the Great Depression of the 1930s.
Another important political development has been the end of the Senate’s flirtation with imposing a tax on carbon-dioxide emissions, aimed at curbing greenhouse gasses that supposedly cause purported global warming. Two weeks ago the Senate rejected a bill introduced by Schumer (yes, him again) and Joseph Lieberman (D-Conn.) that would have forced industries to reduce emissions to an extent that would have been devastating to the US economy.
A slightly less draconian tax was suggested by Jeff Bingaman (R-N.M.), and for a while it looked like it would get bipartisan support from Pete Domenici (D-N.M.), who sits on the powerful Energy Committee. Fortunately, Domenici has backed off.
Cutting carbon emissions has been high on the agenda of this week’s G-8 conference in Gleneagles, Scotland, as well — with Britain’s Prime Minister Blair even coming to the US to lobby congressmen about it. Last week Bush made it perfectly clear that he doesn’t intend to sign onto any global warming solution that will weaken the US economy. And I’ll bet Thursday’s bombings will give Bush and Blair something more important to talk about, anyway.
A climate of fear — of protectionism, of possible carbon taxes, and of terrorism — has been weighing stocks down, keeping them at low valuation levels not seen since the panic bottom of March 2003. Events in the last two weeks, including Thursday’s bombings in London, can potentially go a long way to clear the air, and let hope gradually begin to replace fear.
I offer my condolences to the families of those who lost their lives in London. The best tribute we can pay to them is to be fearless, and to move ahead. Life goes on.
The above is a version of an “Ahead of the Curve” column published July 8, 2005 on SmartMoney.com, where Luskin is a Contributing Editor.