Correlation between stock returns and war not clear

By DAVID MOON, Moon Capital Management, LLC
November 18, 2012

The investment risk or benefit of a particular political party occupying the White House feels real for a lot of people, but data presented in this column last week disproved any historical correlation between stock returns and a president’s political party – although it likely changed no one’s mind.

Another current anxiety-inspiring geopolitical risk is the prospect of Middle East nuclear proliferation and its attendant implications. What has been the investment and economic impact of wars (both declared and not) and the general uncertainty that accompanies the threat of military actions?

The data are less clear with wars than with Democrats and Republicans.

One anecdotal, but powerful observation is that the mere existence of a military or security threat does not create negative stock returns. Nor does the absence of such a threat. That is, don't assume that the pall of militarism or terrorism necessarily depresses stock prices.

The Tel Aviv TGA-100 Index is the Israeli equivalent of the S&P 500. In the ten years ending December 31, 2011 the total return of that index was 114 percent.

The total return of the Australian stock index (S&P ASX 200) was 18.1 percent.

I don’t know how to quantitatively measure the likelihood of military action over the next ten years, but it’s clearly higher in Tel Aviv than in Melbourne. And it certainly was during the past ten years.

On this day in 1940 Adolph Hitler and Italian Foreign Minister Galeazzo Ciano met to discuss Benito Mussolini’s disastrous first attempt to invade Greece. The US stock market proceeded to increase 54.9 percent during World War II and 56.3 percent in the ten years following the US entry into the war.

Also on this date in 1961, John Kennedy sent 18,000 military advisors to South Vietnam. In the ten years following the start of the Vietnam War, the US market declined 42.5 percent.

One of the practical problems in measuring the correlation between stock returns and war is choosing which military actions to include in the analysis. The two World Wars, the two Iraq, Korea and Vietnam are obvious. But a major concern today includes the possibility of preemptive action by Israel against Iranian nuclear facilities. Do you include previous wars such as the 1948 Arab-Israeli War? The eight-year Iran-Iraq War? The 19th century Spanish American War?

The US stock market returned more than 100 percent in the decade following the first Indochina, Gulf, Korean, Arab-Israeli and Iran-Iraq wars.

The ten-year returns were less than 25 percent following the Spanish-American, Vietnam and first World Wars.

GDP growth exhibits a similarly unpredictable lack of pattern. That is, there is no evidence that knowledge of an impending military action would provide any advantage in forecasting longer-term changes in economic activity.

Surprisingly, even GDP contractions during wartime haven’t been obviously correlated with coincident corporate earnings. During some wars, corporate earnings grow at robust rates. (Example: the first and second Gulf wars.) During other conflicts, earnings growth was positive, but almost anemic (Vietnam and WWII.)

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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