Grappling With an Old Enemy

Resurgent terrorism adds to a fragile market's concerns, but major averages prove resilient.
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While value-conscious investors were able to put bloody scenes of London out of their heads by the market's close, the long-term impact on an already fragile world economy of Thursday's terror attacks remains an open question.

Like other major stock proxies, the

Dow Jones Industrial Average

swooned at the open, losing nearly 100 points as money flowed into safe-haven assets like Treasuries, gold and the Swiss franc. The 10-year Treasury added more than a point before stocks opened in New York, while oil plunged on worries about tourism.

Yet the major indices managed to scrape back into positive territory as bonds' gains faded. The Dow finished up 20.74 points, or 0.2%, to 10,291.42. The

S&P 500

, which traded as low as 1167 before the market's open, finished at 1196.83, up 1.89 points, or 0.3%. The

Nasdaq Composite

rose 5.96 points, or 0.29%, to 2074.61.

Pundits chalked up the rebound to resignation among investors that terrorism isn't going away.

"The risk premium linked to terrorism has been there lurking beneath the surface," says Owen Fitzpatrick, head of U.S. equity trading at Deutsche Bank. "The first real surprise was 9/11, but we've been living with it, and there's been some adjustment to it."

Still, the action in oil and a handful of airline and hospitality stocks suggests not everyone is convinced Thursday's impact won't be greater.

Delta

(DAL) - Get Report

,

AMR

(AMR)

,

Starwood

(HOT)

and

Hilton

(HLT) - Get Report

all ended lower, while oil shed 55 cents to $60.73.

Evaluating the impact of events such as the London bombings on the economy and markets is always tricky. On a short-term basis, stocks fall, according to Standard & Poor's chief investment strategist Sam Stovall.

Studying the aftermath of market shocks in U.S. history -- Pearl Harbor, the Cuban missile crisis, the Kennedy assassination, Iraq's invasion of Kuwait, and 9/11 -- Stovall found that the market usually experiences heavy selling for about five trading days, with average price declines of about 6%.

Assessing longer-term market consequences is much harder, however, requiring the synthesis of subtle factors like the impact on both consumer and business confidence. Some observers have noted that the Madrid bombings in March 2003 didn't cause a sustained impact on the world economy. Still, Madrid is not the financial capital that London is.

At the moment, a coordinated monetary response to the terrorism seems unlikely. Fed Chairman Alan Greenspan, Bank of England Governor Mervyn King, and European Central Bank President Jean-Claude Trichet met Thursday and concluded that "markets were functioning" and that there was no immediate need for intervention, Trichet told a news conference.

Central banks, Trichet said, should act as an anchor of confidence. But should the circumstances deteriorate, "you can be sure that we would

act immediately," he said.

Unless there is another attack, the events of Thursday almost surely will not pressure the Fed into pausing its year-old rate-hike campaign. A bounce back in consumer confidence in June, strong retail sales, strong economic indications recently -- improvement both in manufacturing and the service sector -- and continued home-price appreciation, all argue in favor of the Fed sticking to its current tightening schedule, says John Lonski, senior economist at Moody's.

Strong June chain-store sales overall, and especially from the likes of

Target

(TGT) - Get Report

and

Best Buy

(BBY) - Get Report

, press the same theme. Likewise, Friday's employment report for June is expected to show a strong rebound.

"If the Fed were due to meet tomorrow, perhaps this event might have caused the

central bank to seriously think about some temporary delay until the news became clearer," said Bill Dudley, an economist at Goldman Sachs. "Given that they moved last week and won't meet again until Aug. 9, it is unlikely to be a significant factor by then."

Still, a general resurgence of terrorism coupled with high oil could make consumers more cautious and lead to a renewed dip in confidence, according to Bill Dudley, economist at Goldman Sachs.

The biggest impact will be, obviously, in the U.K. Beyond the bombings' symbolic timing to coincide with the meeting of G8 countries in Scotland, it also occurred as the BOE's Monetary Policy Committee was scheduled to make its decision on interest rates Thursday. As it happens, U.K. rates again were left unchanged at 4.75%, where they've stood since August last year.

However, the BOE, which was already leaning toward a cut in interest rates, may now be closer to that step. The British housing market, which has been booming over the past several years much like in the U.S., has started to slow recently, dampening British consumption.

"We thought that the Bank of England was inclined toward cutting interest rates at the August

Monetary Policy Committee meeting even before today's attacks," Goldman's Dudley wrote to clients. "At the margin, this probably adds to the likelihood."

As for the ECB, it also will remain on alert. So far, it has resisted pressure from the European Parliament to cut rates, which would further hurt the euro and make exports more competitive. A lower euro would also make high energy prices even more expensive and further cut into the already sluggish growth of eurozone countries.

To view Aaron Task's video take on today's market, click here

.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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