WASHINGTON, Aug. 3 (UPI) -- The nation is on heightened terrorism alert, while the conflict in Iraq continues to show no signs of calming down. Oil prices, meanwhile, remain significantly higher than they were a year ago, and at the same time, interest rates are going up.
Such political risks and negative economic factors would seemingly make U.S. assets less attractive, or at least keep investors from buying up stocks. Yet the financial markets have been holding up remarkably well, while the greenback is actually gaining strength, at least for now.
"While terrorist threats may raise the market equilibrating risk premium, reducing stock valuations, investors will earn good rate of returns if they buy at such depressed levels," said Charles Lieberman, chief investment officer at Advisors Financial and former New York Federal Reserve Bank economist.
The Department of Homeland Security raised its assessment of the terrorist threat level to code orange, the second-highest level of alert, over the weekend. Moreover, it warned that five financial centers were at particular risk of attack, namely the New York Stock Exchange, the Citigroup headquarters, the Prudential financial center, and the headquarters of the World Bank and the International Monetary Fund.
Apart from increasing the sense of negativism in the markets, the heightened level of terrorist risk has a very real destructive impact of increasing risk premiums for businesses, particularly in potential target areas such as New York and Washington.
Nevertheless, both the Dow Jones and Nasdaq markets found themselves inching up higher during Monday's trade, and the Dow is actually well above the psychologically critical 10,000-level, having reached below 9,000 a year ago.
Such an upward trend in equities is not surprising though, according to Lieberman.
"The economy is very healthy and a terrorist attack today, unlike 9/11, would not be a total shock," he argued, adding that after the attacks of September 2001, the U.S. economy was able to rebound. Moreover, Lieberman said that "the stock market of that period was hurt far more by the poorly performing economy than by the terrorist attack."
Certainly, looking at Spain's growth prospects despite the train bombings in Madrid earlier this year, it could be said that the detrimental effect of terrorist attacks on the overall economy could be relatively contained.
Some analysts argue too that the Homeland Security Department had raised the level of alert a number of times over the past few years, but as nothing happened in the end, it is tempting to believe that the latest alert too would not be necessary.
So that allows investors to focus more on the more concrete economic data, which have been quite robust over the past few months. Indeed, significant improvements in the labor market as well as capital expenditure and consumer spending have pushed the Federal Reserve to boost interest rates once again, having kept cutting rates steadily since January 2001. The key federal funds target rate stands at 1.25 percent since June, and many economists expect the Fed to continue boosting rates gradually in light of the economic upturn.
Meanwhile, should there be another terrorist attack or a situation that leads the U.S. economy to head south, investors remain confident enough that the central bank will step in and slash monetary policy accordingly as it did following the Sept. 11 strikes.
Such confidence in the economic fundamentals and the ability of the Fed to steer the country's economy towards growth is also being reflected in the currency markets as well as the equities market, as the greenback steadily increases in value against both the euro and the Japanese yen over the past few weeks. That trend is continuing despite the increased risk of a potential terrorist attack on major U.S. financial institutions.
As for the continued rise in oil prices, with crude reaching over $43 per barrel Monday, some such as celebrity economist Lawrence Kudlow argue that on the one hand, economies are less dependent on petroleum than they were two or three decades ago. But more importantly, he and many other economists argue that the recent surge in oil prices merely reflects growing demand from rapidly expanding developing countries such as China and India, and that in turn would only lead to more growth worldwide.
Yet while some investors can and have shrugged off the risks of terrorism and higher energy prices, many economists are worried about another unknown factor, namely the presidential elections in just over three months' time.
With many voters worried about their personal finances and job security despite the steady recovery of the economy at large, "this upheaval is creating uncertainty, fear, and some pessimism," said Brian Wesbury, chief economist at investment group Griffin, Kubik, Stephens & Thompson.
Instead of fretting about whether or not a terrorist attack could happen again soon, many investors are more concerned about the upcoming elections and the policy changes that could be put into place with a new administration, or the continuation of the current one, and whether that could lead to tax cuts or tax increases that could lead them to shift their investment portfolio.
