September 4th, 2002

Preparing for 9/11/2002 - What to Expect

The Psychology of Market Participants Heading Into, On and After 9/11/2002

While it would be best never to mention the subject of the events of 9/11 other than to honor the memory of those that perished and acknowledge the heroes of such a tragic day, it is important to realize that commodity and stock markets will act differently because of those events as we approach the one year anniversary of 9/11.  It is important to prepare and analyze, for your own financial well-being, the psychology of those trading the markets to best handle the market activity we are about to see. 

Most traders avoid the psychological aspect of markets and concentrate on charts or fundamentals, volatility or volume, advice or commentary and so on and so forth to generate trading decisions.  However, it is at a time like this that one must focus almost entirely on the psychology of the marketplace as it will be the dominate force in price action over the next several weeks.  What are traders really worried about?  Is it market hysteria or reserved caution?  Will traders avoid the markets or aggressively pursue them?  Let’s look at some facts and observations to generate two theories of market psychology. 

The average investor is worried not of another terrorist attack in and around 9-11, but in fact they are worried that everyone else is worried about an attack and will sell stocks as a protective measure against hysteria and massive selling.  This will cause a downturn in the market ahead of 9/11, but offer a bottom/buying opportunity after 9/11 as the market participants will find renewed comfort in reentering the market.  Bonds will react inversely, as the downturn in the market will offer a flight to quality and rally in the bond market (which, not coincidentally coincides with the technical break of the triple top high on the 30yr just the other day).  Once a flight to quality is no longer in the cards bonds should deflate to lower and more rational levels.  Want to test this theory?  Ask 10 stock investors these two questions:  Are you worried the US will be attacked by terrorists on or near 9/11?  Few will answer yes.  Are you worried that investors will sell stocks ahead of 9/11?  An overwhelming amount will tell you they are.

Another theory suggests that volume will temporarily leave the market as investors ‘freeze’ their holdings in an attempt to not act irrationally and miss a market move.  This is supported by a fairly simple psychological premise.  The fight or flight theory suggests that when encountered by a situation that could cause you harm, human instinct takes over and you either fight or run away.  However, when dealing with money, which has an indirect relationship with your personal health and well-being, one tends to do neither.  This is the origination of the buy and hold philosophy stock brokers have been pitching clients for years.  There is little reason to doubt this occurring ahead of 9/11, when brokers are trained ahead of time for this exact situation.  Selling is not a profitable situation for brokers if you are not buying something else.  If there is a ‘freeze’ in the average speculator’s investments then one must look to fund and institutional traders to influence market direction (more so than normal).  Institutional traders will almost always play the safer side of any scenario, looking to protect their assets and in turn their jobs.  If a mutual fund manager had the choice to subject themselves to an historically volatile day or sit on the sidelines, he would intelligently sit on the sidelines.  Given recent fund performances, he does not need to make a fortune in the market to preserve his job or paycheck.  He simply needs to protect assets.  Fund liquidation will force a similar but slightly different scenario to the first theory.  When funds liquidate and speculators take the losses it often leads to a prolonged price drought.  A speculator has already discounted an acceptable loss on his or her trades given the buy and hold logic mentioned above, and the funds look good because they are not losing money during a time of weak prices.  This will create a wait and see approach for institutional investors and cause a lag or delay in market recovery.  This suggests the market may not reach a bottom on 9/11.  The argument against this theory is that the reason for sell pressure will be alleviated on 9/11 and fund managers are not historically successful when removing themselves from the market for just a few days.  History shows that funds move positions to cash for extended periods of time and that logic would suggest that the managers apt to do so already have. 

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