The stock market reacts to uncertainty – and there’s nothing more uncertain than a stray missile, or full-blown geopolitical conflict and warfare. Financial media outlets thrill to feed into alarmist sentiment surrounding an impeding war. But should equity investors be daunted in their investment brevity in the face of a potential war threat? We turn to the U.S. equity market to test this theory. Since the foundation of the S&P 500 in 1957, the U.S. has engaged in a whopping 21 fully fledged military campaigns. So how did all of this warfare affect America’s market performance?
A 2013 study of U.S. equity markets conducted by the CFA Institute has shown that in the month after the U.S. enters conflict, the Dow Jones has risen, on average, by 4.0 percent. The Institute reported that exempting the Vietnam War, during which stock returns fared worse than the full period average of the study, both large-cap and small-cap stocks outperformed the market with less volatility. Even the war in Afghanistan, which was excluded from the study, proved unfatal to the stock market. Despite declining for the first two weeks after 9/11 by 11%, the S&P 500 quickly gained back 5.6% in the six months following the attack.
It is also interesting to note that, according to the study, stocks proved to be less volatile than bonds or cash. This may be attributed to the economic factors that impact bond prices during periods of war, such as higher inflation and increased government borrowing during wartime. This is a surprising find, especially considering that bonds are typically thought of by investors as a “safe-haven” investment during uncertain times.
What could be some explanations for the relatively strong performance of stocks during wartime? A potential argument could be increased government spending, which leads to increased revenue for U.S. companies with government contracts. Another could be heightened patriotism in investing: when faced with two businesses that offer the exact same service for roughly the same quality and price, an assumption could be made that investors would likely invest in the American company.
It appears to be the data-backed consensus that U.S. stocks tend to remain resilient in the face of military conflict. War risk in equity valuation, then, seems to be rhetoric dependent, rather than based on facts. However, two concerns with this conclusion must be made. One is that although the above data is reassuring to some equity investors, it must be acknowledged that the U.S. also tends to emerge victorious from armed conflict, especially when pitted against third world countries. It is entirely probable that had the study drawn attention to countries that are less militaristically resourceful, stock market volatility would have been very different. Furthermore, although the stock market seems to perform well during wartime, attention should be drawn to the fact that the definition of “war” itself is slowly shifting away from brute military strength to trade wars, cyber-security warfare, and so on. The scales may still tip as geopolitical power dynamics continue to shift.