How Do Wars Affect Stock Prices?
Sell-side research sententiously advises us to be wary of the risk “geopolitical instability” poses to international equity markets. Indeed, the financial media thrill to alarmist predictions of impending war. But should the threat of international conflict keep equity investors up at nights? Or should they instead tune out the constant chorus of “Bomb, bomb, bomb, bomb, bomb Iran”?
The UK equity market provides a testing ground for this theory. Since the inception of the FTSE 100 in 1984, the Brits have engaged in no less than eight fully-fledged military campaigns. This amounts to 26 out of 34 years (76%) spent fighting other countries
Figure 1: Conflicts involving Britain since 1984, incl. date involvement became public knowledge
Source: Wikipedia
How did all of this warfare affect the equity market? Israeli author Lavie Tidhar joshed that, “The English … had once conquered most of the known world, but their cooking hadn’t improved as a result.” Our research suggests that Britain’s stock market has fared better than its cuisine.
UK equities have appreciated during the first ten days of every single recent conflict in which Britain has participated. During the first ten days of the Kosovo and Libyan wars, for example, the FTSE 100 rallied by 3.8 and 5.4 percent respectively. More broadly, this translates into average gains of 2.86 percent for the FTSE 100, 2.46 percent for the FTSE All Share, and 4.41 percent for defense stocks (LSE:RR, LSE:BA, LSE:BAB, LSE:SRP, LSE:COB).
Figure 2: Average stock price before and after the announcement of conflict (+/- 10 days)
Source: CapitalIQ
Not only do UK equity markets shift notably higher during the first ten days of conflict, they also tend to quickly recover any prior losses within the first three months. In five out of the eight campaigns Britain has waged since 1984, the markets have more than made up lost ground within one month. Within three months, this number increases to seven out of eight campaigns. Indeed, the first three months of conflict average returns of 17.5 percent versus a little under 2 percent across all three-month periods since the FTSE 100 began.
Figure 3: Average price movement before and after the commencement of conflict (+/- 90 days)
Source: CapitalIQ
While it would be crude to suggest investors relish the advent of British entry into war, there is at least comfort to be taken from the fact that UK equities at the very least tend to remain resilient in the face of conflict (as existing research on US markets has similarly found). It is thus tempting to dismiss the theory of “war risk” in equity valuation as strong on rhetoric but weak on fact.
Our research is not alone in reaching this conclusion. A 2013 study of US equity markets found that in the month after the US enters conflict, the Dow Jones has risen, on average, by 4.0 percent—3.2 percent more than the average of all months since 1983. A 2017 study found that volatility also dropped to lower levels immediately following the commencement of hostilities relative to the build-up to conflict. During the four major wars of the last century (World War II, the Korean War, the Vietnam War, and the First Gulf War), for instance, large-cap US equities proved 33 percent less volatile while small-cap stocks proved 26 percent less volatile. Similarly, FTSE All Share and FTSE 100 volatility has historically fallen by 19 and 25 percent over one- and three-month horizons following the outbreak of conflict.
Figure 4: Capital Market Performance During Times of War
Source: The ACM Journal
While certainly reassuring for some equity investors, there is, however, a geographic limitation both to our study of UK equity markets and the 2013 and 2017 studies of US equity markets: both concern countries that are highly prone to winning wars. Had we studied countries prone to losing wars (rather than back-to-back world war champions), results may well have been different.