Sunday, 1 February 2015

Let Slip the Stocks of War

War is widely seen as indefensibly evil. Edwin Starr's question, "What is it good for?" is clearly rhetorical. However, some like yours truly have a macabre fascination with the notion that it can enrich.

The link between war and wealth was probably around before Nathan Rothschild reputedly used advance knowledge of Wellington's victory to enhance his fortune. God ordered the Israelites to plunder their enemies with fluctuating specificity. A family story has my great-grandfather reaping huge profits from selling surplus American military landing craft (that he just happened to have lying around the yard.) America's last wars in Afghanistan and Iraq are cast as cynical ploys to create customers out of victims.

Keep Calm and Invest.
Data tells its own story. In particular, we can cross reference periods where the U.S. was at war, against the S&P500 and its precursor index from 1940 to 2014. I would think that the massive government spending in mobilising a war effort would provide a Keynesian kick to both the stock market and inflation. Indeed, one analyst observed weakness up to the point the last two Iraq wars were declared, and strength thereafter. Others simply remind investors to stay their course.


Average Change on Previous YearOverallWar yearsNon-war yearsStd Dev
S&P500 Index7.96%8.66%6.06%13.49%
Company Earnings10.28%9.57%13.25%39.27%
Dividends1.83%1.86%1.80%6.66%
Consumer Price Index3.89%3.04%6.96%3.19%
Index – CPI4.07%5.62%-0.90%
Dividends – CPI-2.06%-1.18%-5.16%

The volatility of the index, expressed in the standard deviation, indicates that the difference between war and peace is not statistically significant. More significantly (but still falling within one standard deviation of the average), it is hard to ignore the higher inflation in peace-time.

So how did the model above return such huge real returns when it seems that investments went backwards in periods without conflict? The answer is simply that there was a lot more war than peace. In the seventy-four years, there were only eighteen where the U.S. was not fighting.

Which brings us to this exercise's biggest weakness: the arbitrariness of war. I used Wikipedia's list of U.S. wars, but a different measure may provide different dates for the start and end of a conflict. And the index is volatile enough for a year here or there to make a huge difference to aggregate figures. Had I used periods where America's military was 'on operations', there would have been no times of peace to work with.

The last two decades has seen America constantly at war because it has engaged in an increasing number of theaters causing overlapping periods of conflict. More war, not any significant market correlation, is the clearest prediction I can make.

Should Mr Starr be open to responses though, war may be a friend to savers as well as the undertaker.

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