Would A War With North Korea Be Bad For Stocks?

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 |  Includes: SPY
by: Jeffrey Robinson

The world is a tumultuous place, filled with war, recessions and natural disasters. An investor should not underestimate the impact of these events on the markets. Wars in particular can have an economic impact, and perhaps more importantly, a psychological impact on the investor community. As tensions rise between North Korea and South Korea, whether serious or not, it would be interesting to consider what impact a larger-scale war would have on the U.S. economy if the situation escalates. This is a general discussion on the history of war and the markets, and I won't be speculating on whether there will be another Korean war.

The Herd Mentality

Despite what we've been told, the markets are not controlled by robots. Even program trading has to be programmed by a person, with assumptions built into the program that a person derives. Human beings act based on their emotions and often operate with herd mentality. In the wild, animals group together and move in large packs across the land. If a predator approaches, the herd is alerted, and it begins to run as one group. We don't move around in packs like animals, but we do watch television, read magazines and listen to the radio. Through the media, we are susceptible to "group think" when it comes to the happenings of the day, and as far as popular opinion goes, we begin to operate as one herd. Our perception of war is no exception, because our impressions are coming directly from pictures and images the media presents.

Is The War Popular?

War itself has a significant impact on the movement of the herd within our society. The popularity of the war is the most critical component in determining what psychological impact on the markets one would expect from the war. For example, World War II was a well-supported war because people saw the destruction of Pearl Harbor and the dangers of Hitler's advance as threats to their way of life. Contrast that with Vietnam, a lengthy war that saw diminishing support as it dragged on many years and cost many lives.

The way a war is perceived is a litmus test for the mood of the times. With World War II, society appeared hopeful and motivated to destroy the enemy. What may have started out in a similar way with Vietnam soon turned to pessimism and despair. How could this not have an impact on the way people invested?

Market Returns During War Time

In the table below, I show the returns for the Dow Jones Industrial Average during all major war campaigns since 1896. I defined a "major war campaign" as a war with significant troop deployments, a formal declaration by Congress and a significant length. It was generally easy to find a beginning date of war based on actions of Congress, but the end dates are much trickier because some wars didn't have clear endings. In some cases, I used the passage of a treaty or a major troop withdrawal to mark the end.

War Begin Date End Date Dow % Gain/Loss
Spanish-American War April 20, 1898: Joint resolution August 7, 1898: Major troop withdrawal +27%
World War I April 6, 1917: Formal declaration November 11, 1918: Surrender of Germany -6%
World War II December 8, 1941: Formal declaration September 2, 1945: Surrender of Japan +55%
Korean War June 27, 1950: Truman's formal statement July 27, 1953: Armistice with North Korea +27%
Vietnam War August 7, 1964: Gulf of Tonkin Resolution April 30, 1975: N. Vietnamese President Surrenders -3%
Gulf War January 12, 1991: H.R.J Resolution 77 February 28th, 1991: Iraqi troops withdraw from Kuwait +16%
Iraq War (War on Terror) March 3, 2002: Joint resolution October 21, 2011: Major troop withdrawal +24%
Average: +20%
Click to enlarge

The average gain for the Dow during a time of war was 20%. However, this alone does not tell the whole story. I think a greater insight comes from looking at a chart of the Dow with the war years highlighted.

Periods of Boom and Turmoil

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*orange highlighted periods denote war-time

From the chart, a clear pattern emerges, and war is at the heart of this pattern. Periods of war often start during times of economic and market turmoil. Whether one causes the other is beyond the scope of this article. However, it should be clear that although wars were good for the markets from beginning to end on average, they usually were not good periods for the market generally speaking. They were actually pretty volatile.

I believe this is because of the emotional toll the wars took on the population, who were reluctant to be optimistic and invest during times of great uncertainty. No period demonstrates it better than the Vietnam war. So many young people were angry with the government or worried that they would go to war that it weighed on the markets and economy. The mood was sour.

There are a lot of similarities between that period and the last decade, where a series of unfortunate events caused market and psychological turmoil. The tech bubble bursting was the first event, followed by the 9/11 attacks, the subsequent housing bubble bursting and the financial crisis. The war also became very unpopular towards the end of Bush's second term. There were mass protests against the war, as well as Occupy Wall Street protests after the financial crisis. Add all these things together, and it's not difficult to understand why people are still pessimistic and skeptical of the markets. The mood is very sour. The question is whether the past pattern will repeat, and a time of turmoil will be met with an economic boom.

Are We Due for A Boom?

I think so. I can't say that we've begun that leg of the market yet or if there's more volatility to come (although I've made the case that there won't be more volatility here). History suggests that extended periods of turmoil like the last 10 years will be met with an economic expansion. What if we go to war with North Korea? What should investors watch? Of course, the nature of the war would determine the impact to the markets, and there are many unknowns. Past history says markets tend to rise 20% from the beginning of the war to the end. If we do go to war again, I believe the key to the market's reaction will be how popular the war is. A very popular war will have no impact on the markets, but an unpopular one could create a period of high volatility.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.