Terror Fears Have Held Back Stocks

Three years later, it's still insensitive to speak openly and directly about how Sept. 11, 2001, transformed the investment climate.

But the tragedy that killed roughly 3,000 innocent people, destroyed New York's World Trade Center and damaged the Pentagon also left an unmistakable legacy for investors -- an omnipresent element of risk that has kept stock markets from rebounding as vigorously as consumer confidence and the economy. On this third anniversary of 9/11, there is little evidence that the terrorism discount is going away.

"There is a genuine concern out there that we could all wake up the next morning and something has happened and the market could go down 20% or 25% instantly," said Alfred Marcus, a business school professor at the University of Minnesota.

To be sure, the U.S. stock market has recovered from its post-9/11 swoon. Three years after 9/11, the Dow stands 7% above its Sept. 10, 2001, close. The S&P 500 is just 2% higher while the Nasdaq Composite has gained 12% -- albeit after a devastating peak-to-trough decline during the bear market of 2000-02.

But this progress has been indirect and relatively restrained. During the same three years, the recession ended -- with GDP now having expanded for 11 consecutive quarters, including by 7.4% in the third quarter of 2003 -- while corporate profits rose to record levels. The reported earnings of the S&P 500 totaled $56.10 per share over the past 12 months, 52% higher than the $36.79 reported in the four quarters before 9/11, according to Standard & Poor's.

And the yield on the Treasury's 10-year note, which goes down when bond prices gain, has dropped to 4.20% from 4.84% the day before the attacks. The fed funds rate dropped from 3.5% prior to 9/11 to as low as 1% in June 2003, where it remained until the Fed's rate hike in June.