STOCKS AND WAR
Since 1885, the U.S. economy has been at war or on the sidelines of a
world war about one-fifth of the time. The stock market does equally
well in nominal returns whether there is war or peace. Inflation, how-
ever, has averaged nearly 6 percent during wartime and less than 2 per-
cent during peacetime, so the real returns on stocks during peacetime
greatly outstrip those during wars.
While returns are better during peacetime, the stock market has ac-
tually been more volatile during peacetime than during war, as meas-
ured by the monthly standard deviation of the Dow Industrials. The
greatest volatility in U.S. markets occurred in the late 1920s and early
1930s, well before the United States was engaged in World War II. Only
during World War I and the short Gulf War did stocks have higher
volatility than the historical average.
In theory, war should have a profound negative influence on
stock prices. Governments commandeer tremendous resources,
while high taxes and huge government borrowings compete with in-
vestors’ demand for stocks. Whole industries are nationalized to fur-
ther the war effort. Moreover, if losing the war is deemed a
possibility, stocks could well decline as the victors impose sanctions
on the vanquished. However, the economies of Germany and Japan
were quickly restored to health following World War II, and stocks
subsequently boomed.The World Wars
The market was far more volatile during World War I than during World
War II. The market rose nearly 100 percent during the early stages of
World War I, then fell 40 percent when the United States became in-
volved in the hostilities, and finally rallied when the Great War ended.
In contrast, during the six years of World War II, the market never devi-
ated more than 32 percent from its prewar level.
The outbreak of World War I precipitated a panic, as European in-
vestors scrambled to get out of stocks and into gold and cash. After Aus-
tria-Hungary declared war on Serbia on July 28, 1914, all the major
European stock exchanges closed. The European panic spread to New
York, and the Dow Jones Industrials closed down nearly 7 percent on
Thursday, July 30, the most since the 8.3 percent drop during the Panic
of 1907. Minutes before the opening of the New York Stock Exchange on
Friday, the exchange voted to close for an indefinite period.CHAPTER 13 When World Events Impact Financial Markets 231