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Looking at how markets have reacted to war

Updated: May 3, 2013 12:14PM

Originally published: January 30, 2003

Is war good for the economy and the markets?

It’s a troubling question. Yet generations of high school history students have been taught that it took World War II to finally bring the United States out of the Great Depression. That may be true, but many other lessons of history refute the concept of war as an economic stimulus.

Lately the stock market has been reflecting those historic lessons, falling sharply as war appears imminent. But there’s more to the complex issue of war-and-economy than market volatility. Chicago economist Robert Genetski has just released a study of the impact of war on the financial markets and concludes, “Once the war begins (or perhaps even before it begins), stock prices are likely to rise in anticipation of relatively quick victory. If all goes well, the removal of a major risk to the U.S. and world economy should send stock prices soaring.”

Of course, there are some caveats to that prediction. Genetski says that if the battle were to be prolonged, or if there were significant loss of life as a result of chemical or biological warfare, any market rally would be quashed. Those are not considerations today’s investor is used to contemplating.

War and the market

A look back at history is instructive. Yes, it’s true that World War II mobilized our economy, and it impacted our stock market as well. According to a study by Chicago market researcher Ibbotson Associates, the stock market gained a total of 81.4 percent in the three years after the shock of Pearl Harbor. Even in the midst of privation and rationing, the stock market managed a significant gain.

In the early 1990s, the market had a similar reaction to the Gulf War. As Genetski notes, stock prices had already hit their lows in October of 1990, though the bombing of Iraq did not begin until February 1991. The S&P 500 index gained a cumulative 57.7 percent in the three years after the Aug. 2, 1990, Iraqi invasion of Kuwait.

The Korean War also ended with higher stock prices. When the war started in June 1950, stock prices dipped. But by the end of the war in July 1953, the stock market had gained 61 percent, according to Alexa Auerbach of Ibbotson.

The Vietnam War arguably dragged on from the Gulf of Tonkin resolution in August 1964 until the last Americans fled in April 1975. During that period, the stock market had huge--at the time--rallies, trading over 1,000 for the first time in 1966 and again three years later. But there were also huge declines, with the Dow trading below 600 in 1974. According to Ibbotson, the total cumulative return of the S&P 500 during that nine-year period was a gain of 51 percent.

The way the United States finances a war has the potential for greatest impact on the economy. The 1991 Gulf War was financed in large part by our allies. The impact on the U.S. budget deficit was not dramatic. In fact, after the Gulf War, the U.S. budget deficit began a nearly decade-long decline.

President Bush’s State of the Union message Tuesday made no mention of how the coming Gulf War, as well as his proposed health care and other social plans, would be financed. The budget deficit has already grown. Without any firm indication of how long a war might last, or who might join in paying for it, it’s difficult to project the impact on the economy.

Genetski notes that in 1990-92, during the period around the Gulf War, long-term interest rates in the United States remained fairly stable. His view is that interest rates appear to respond more to trends in the domestic economy than to events associated with war.

Inflation lurks

But there are risks, says Genetski. “If there is any indication that either the military campaign or its aftermath will provide a significant drain on U.S. resources, this would send both inflation and interest rates sharply higher.”

The rising value of stocks in these previous historic examples might simply be attributed to the ability of the U.S. economy to overcome adversity. But there’s no doubt that the resources--of both human capital and investment capital--that would be expended in a war could be put to use in more productive ways. The real cost of war is the diversion of those resources. And that’s The Savage Truth.

Terry Savage is a registered investment adviser and is on the board of directors of McDonald’s Corp. She appears weekly on WMAQ-Channel 5’s 4:30 p.m. newscast.

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