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.
The market's lack of pop despite such positives reflects a reassessment of risk in the wake of the Internet bubble. The S&P 500 was trading at a price-to-earnings ratio of 37 at the end of June 2001. The ratio was less than 20 three years later, and the market has traded down since then. Not surprisingly, onetime dot-com darlings such as Internet Capital Group ( ICGE) and Priceline.com ( PCLN) are among the worst performers in the past three years. (Conversely, security outfits such as Viisage Technology ( VISG), Magal Security ( MAGS) and Kroll ( KROL), which is being acquired by Marsh & McLennan ( MMC), are among the best performers since 9/11.) As P/Es have come down, the price of oil has risen, although as much as $10 a barrel of the rise may reflect a "terrorism premium." Many analysts also attribute the stock market's relatively lackluster gains in part to investor fears of subsequent terrorist attacks in the U.S. or the oil-rich Middle East. To the surprise of some, such fears persist despite the calm that ultimately prevailed at the Olympic games and Democratic and Republican conventions this summer. "I would have thought that people would be more anesthetized to it by now," said Sam Stovall, chief investment strategist for Standard & Poor's. "But it's always remaining in the background and convincing people to be more conservative."
Money has also chased real estate. Mortgage debt has increased by $2.1 trillion since 2000 to almost $6.9 trillion at the end of the first quarter, according to the Fed. Corporate managers are doing the same thing, with cash holdings exceeding $1 trillion according to the Fed. Research by Moody's Investors Service found that companies had cash on hand equal to almost one-quarter of their long-term debt, the highest ratio since 1969. The amount of cash was almost 1.5 times the amount spent on capital projects, an all-time high, Moody's said. "Why are corporate managers being so cautious relative to available resources?" asked Richard Cripps, chief market strategist at Legg Mason in Baltimore. It's simple, he said: "risk aversion" in the wake of terrorism fears.
What could alleviate some of the fear and bring money out from under the mattress and back into the equity market? Professor Marcus says stability in Iraq, with a diminished U.S. role, would help. But don't stay up waiting for the capture of Osama bin Laden, he says. That might only provoke more attacks. And although the market rallied after Saddam Hussein's capture last December, those gains all but evaporated over the summer. It has become a cliche to say "everything changed" after 9/11, but there's evidence to suggest it's true. Beyond the immeasurable personal tragedy of the attacks, the price of fear in the aftermath continues to extract its toll on all of us as reflected in the retreat from risk that sometimes ebbs, but remains ever present.