"Kee Points" with Jim Kee, Ph.D.


  • Stocks and War
  • Stocks and Military
  • Secrets Stocks and North Korea

 

 

Stocks and War 

 

How do stocks react to war? Last week was dominated by geopolitical concern, as markets sold off (S&P 500 down -1.3%) in response to tensions between the United States (primarily) and North Korea. The relationship between stocks and geopolitical events/war is pretty surprising: in bull markets (like the current market), stocks tend to, on average, decline about -4.3% following a major shock, but have typically bounced back within an average of 37 days (Crandall, Pierce & Co). This includes everything from the Cuban missile crisis to Watergate. So if stocks had been in an upward trend prior to the shock, they have tended to sell off briefly and then resumed their upward trend. Conversely, when stocks were heading down (i.e. in a bear market) when a shock occurs, they tended to continue the downward trend after the shock. In contrast, had you sold stocks at the beginning of last year and “moved to the sidelines” in response to the “worst start for stocks since the Great Depression,” (Wall Street Journal) your wealth would be over 30% lower today. Interestingly, of the largest geopolitical events that have occurred over the past 80 years, only a handful (e.g. German occupation of France in 1940 and the Arab Oil Embargo of 1973) produced wealth declines on-par with moving to cash following the sell-off at the beginning of 2016, and both of those shocks occurred during a bear market. To be clear, attempting to time the market last year would likely have been much more detrimental to your wealth than the vast majority of geopolitical events of the past 80 years.

 

 

Stocks and Military Secrets


A stock market story that everyone should know! One of the most fascinating (and true) stories of war and the stock market involved economist Armen Alchian at the RAND Corporation in 1954. Alchian and colleagues were doing economic research and knew that the government was developing the hydrogen bomb, and wanted to know what the essential metal was, i.e. lithium, beryllium, thorium, etc. Unable to find out from his superiors, Alchian looked through the US government’s Department of Commerce yearbook, which listed items on every industry by product, and looked up the suppliers of the various materials. He then called up the brokerage firm Dean Witter (later acquired by Morgan Stanley) and asked them which companies made those materials. By watching the reaction of the stock of each company following the Operation Castle series of nuclear, Alchian was able to guess that the essential metal was lithium (the company was Lithium Corp.). In other words, he was able to determine the fissile (capable of sustaining a nuclear fission chain reaction) fuel of H-bombs through stock prices. He wrote it up and circulated it among the other social scientists at RAND (economics is considered one of the “social sciences”) and later got a call from the head of RAND telling him that they had to suppress it (it was confiscated and destroyed). Said Alchian, “anyway, it made my reputation among a lot of the engineers at RAND.” Sixty years later (2014) economist Michael Newhart replicated and confirmed Alchian’s study in the Journal of Corporate Finance in a paper titled, “The Stock Market Speaks: How Dr. Alchian Learned to Build the Bomb.” Newhard wrote:


“I find significant upward movement in the price of Lithium Corporation relative to other corporations and to the Dow Jones Industrial Average in March 1954; within three weeks of Castle Bravo the stock was up 48% before settling down to a monthly return of 28% despite secrecy, scientific uncertainty, and public confusion surrounding the test; the company saw a return of 461% for the year.”

 

 

Stocks and North Korea


Looking to last week through the “Alchian lens” of the stock market: Looking at the broad S&P 1500 stock index, which contains large (S&P 500), medium (S&P 400), and small (S&P 600) companies, the median company price change or price return for last week was -0.58%, or negative 58 basis points. By comparison, the median return for the 25 Aerospace and Defense industry stocks (of 157 sub-industry groups) was a positive 0.38% or 38 basis points. The biggest gainer in that group was Mercury Systems, which focuses on missile programs like Patriot and Aegis ballistic missile defense systems. It was up almost 8% for the week. Rockwell Collins, whose Electronic Warfare & Intelligence segment focuses on surveillance systems designed to intercept and jam enemy communications, was up 6%. Raytheon (missile defense) and L-3 technologies (surveillance and reconnaissance systems) were also up big. Who would be most threatened if the North Korea situation escalated? Well, probably South Korea for starters (by proximity alone), which would explain why their stock index (the KOSPI) was down over 3% last week. Of course, an equally unpredictable positive turn of events could pull these stocks in another direction, so it is not wise to trade on yesterday’s news!