The recent terrorist attacks in Paris counted as yet another incident in an ongoing asymmetric war.
One side has huge conventional resources but the other side has an ample supply of brainwashed young men and women and every so often, there is a terrorist attack somewhere. It could happen anywhere around the world but is more likely to be noticed if it targets some place in a developed nation. Every such incident sparks off shock and outrage. It is usually followed by some form of retaliation and then this cycle repeats.
It is reasonable to assume this cycle of terrorism will continue indefinitely. It cannot be prevented by normal means of policing and surveillance. There are always disaffected young men and women who can be brainwashed into committing suicide attacks. There are too many 'soft' targets. It is easy to build improvised explosive devices and the world is awash with automatic weapons.
The impact on financial markets is interesting because that also follows a pattern. Every such incident can trigger one or two sessions of panic sell-offs that affect markets everywhere. The local market, wherever that is, is usually hit harder. Tourism stocks - hotels, airlines, cruise lines, travel agents - are generally hit harder than the overall market.
After that brief panic, it's back to business as usual. The markets recover, even if tourism is affected. Terrorist attacks rarely lead to the disruption of business, even when that is the target. For instance, the BSE building in Mumbai was bombed in March 1993. That was in the middle of a bear market and sparked an utter collapse of equity values. Yet, some 18 months after the bombings, the Sensex had doubled in value.
In that sense, every terrorist outrage, which causes a sell-off, also presents a buying opportunity. (I have often wondered in fact, if market-savvy terrorists short global markets before carrying out attacks.) It might sound callous but even as you mourn for the unfortunates who get killed in a terrorist attack, you should probably be buying equity. If you are really confident about your ability to time the markets, you can get a two-way ride by first shorting a market in the aftermath of a terrorist attack, and then buying into it as it recovers.
This is only one of the multiple types of opportunities presented by news-based market moves. There is a certain kind of news which has a very strong probability of creating a short-term downtrend. Apart from terrorist attacks, poor results in one quarter or cases of corporate fraud fall into this category.
Quite often, the long-term impact is less severe than initial reactions. Good companies can register losses in a quarter and bounce back. Fraud also often results in share prices being hammered down to valuations that are really attractive. Look at Satyam. The stock crashed to single digits when news of the fraud came through. A year later, it had yielded 10x returns for those brave enough to buy during the crisis. Of course, when problems of this nature arise, the trader/investor must take a call on whether it is a temporary embarrassment or permanently damaging.
Another news-based situation, news or rumours of a merger, creates short-term uptrends coupled to a high probability of long-term downtrends. The target company usually sees its shares being bid up in anticipation of an enforced open offer. Valuations tend to go haywire in situations of competitive bidding with rivals targeting one company. However, the sad truth is, most mergers don't work. Companies can have surprisingly incompatible work cultures and mergers rarely work as well as envisaged.
These are obviously situations where markets don't work too well in the short term. It would be understandable if these were novel situations. For example, the market has understandable problems with valuations for entirely new sectors. Think of information technology, the internet, biotech, and earlier of credit cards and insurance, among others. In each case, bubbles blew up because investors found it hard to separate real potential from absurd hype.
The surprising thing is that frauds, mergers and even terrorism are not uncommon. Frauds are historically part and parcel of economic life. Mergers are also old hat. Terrorism has been part and parcel of normal life for 20-odd years. Despite this, the market tends to misjudge such situations and that creates an opportunity for traders or investors who can keep cool under these circumstances.
