Author: Li Jia Source: Wall Street News

When the cannon fire goes off, there is a thousand taels of gold. As markets debate whether the conflict in the Middle East will drag down the global economy, both the S&P 500 and the Nasdaq hit new highs. What does the war mean for U.S. stocks?

The Caitong Securities report gave a straightforward answer: The relationship between war and the long-term growth of U.S. stocks is not antagonistic, but closer to symbiosis. The historical performance of the Dow Jones bears this out - it rose 28% during the Spanish-American War, 26% during the Korean War, the Vietnam War lasted 19 years and the index still rose more than 80%, and the war in Afghanistan spanned before and after the 2008 financial crisis, nearly doubling during that period.

Since becoming the world's largest economy at the end of the 19th century, the United States has achieved substantial gains in most of its previous wars except the Vietnam War. From the seizure of Spanish colonies in the Spanish-American War, to the massive war fortunes of the two world wars, to the Gulf War and subsequent small-scale conflicts over oil resources, the United States has completed its transformation from a "war participant" to a "war initiator."

The reaction path of U.S. stocks under fire is also clear: before World War II and before, wars mainly affected the market through emotional shocks; since the Korean War, this direct effect has gradually weakened, and wars have been transmitted to the stock market more through economic channels such as inflation, oil prices, and fiscal deficits.

The Vietnam War was the only war in which the United States lost money, and it also profoundly rewritten its war logic. The conflicts initiated by the United States since then have almost without exception three characteristics: short time, small space, and centered on oil—and they all ultimately achieve their goals.

From "taking advantage of the situation" to actively provoking trouble, the U.S. war strategy has experienced three transitions

The Spanish-American War of 1898 was the first major war initiated by the United States. At that time, domestic monopoly consortiums were in urgent need of new markets, investment sites, and sources of raw materials, and Spain's remaining colonial empire became the best target. After the war, the United States gained control of Cuba and acquired the Philippine Islands, Guam and Puerto Rico. The Dow Jones Industrial Average rose 28% during the three-month war and coincided with frontal battlefield victories.

When World War I broke out, the United States initially remained neutral. During the market close in July 1914, investors realized that the United States would be the greatest beneficiary of the conflict in Europe—far from the battlefield, its homeland could continue to produce and export armaments to Europe. By 1917, American banks, including Morgan, had lent $10 billion to the British and French governments to purchase arms. Although the stock index fell nearly 10% after formal entry into the war in April 1917, the industrial index had risen approximately 107% from its 1914 nadir to March 1917.

World War II was a key battle that established the United States' global dominance. At the beginning of the war in September 1939, U.S. stocks fell for a time because the "excess profits tax" suppressed corporate profit expectations - Congress imposed a tax rate of up to 95% on corporate profits exceeding $5,000, and the DDM molecular side was severely suppressed. It was not until the Battle of the Coral Sea and the Battle of Midway in May 1942 that the tide of the war was reversed. Investors keenly grasped the direction of the war, and U.S. stocks bottomed out and rebounded in advance. The industrial index rose 82 percent in the second half of the war, the transportation index rose 127 percent, and the utility index rose 203 percent.

The Korean War was the first war that the United States "did not win". Although arms demand boosted the sluggish post-World War II economy, the U.S. military failed to achieve its set goals. Still, the Dow Jones Industrial Average was up 26% for the period, and the Transportation Index surged 86%.

The Vietnam War became a watershed. It was the only war in which the United States lost and gained nothing.

The U.S. defense budget soared from $49.6 billion in 1961 to $81.9 billion in 1968 (43.3% of the federal budget), the fiscal deficit rose from $3.7 billion to $25 billion, and inflation rose from 1.5% to 4.7%. U.S. GDP fell from 34% to less than 30% of world output. After the war, the U.S. war strategy completely changed: no longer large-scale ground wars, but "proxy" conflicts with short duration, small casualties, and mainly air strikes.

The subsequent Gulf War, Kosovo War, Afghanistan War, and Iraq War were all initiated by the United States through local conflicts or black swan events. The war locations were mainly concentrated in the Middle East and the Balkans, and the core goals revolved around the control of oil resources and arms demand.

The way the war affects the stock market has changed: from emotional to economic driven

During World War II and before, war events often directly affected investor sentiment. In the Spanish-American War, the victories at the Battle of Manila Bay and the Battle of San Diego Bay both pushed the index up by about 10% within ten days; while in the two world wars, news of the United States' entry into the war often triggered panic declines.

But starting from the Korean War, this direct influence gradually weakened. From November 1950 to February 1951, the South Korean and American coalition forces were retreating steadily, but the U.S. stock market continued to rise. The reason was that the economy that had stagnated after World War II restarted during the Korean War: U.S. GDP at constant prices increased by approximately 8.7% in 1950, and continued to remain above 8% in 1951. The fiscal expansion brought about by the war became a catalyst for economic recovery.

This shift became even more pronounced during the Vietnam War. The Battle of Drang Valley in November 1965 (the first large-scale fierce battle by the US military in the Vietnam War) did not have a significant impact on the stock market; the "New Year Offensive" launched by North Vietnam in early 1968 also failed to prevent US stocks from reaching new highs. What really drove the market was the Federal Reserve's tightening of credit conditions in 1966 in response to Vietnam War spending, and the two economic recessions of 1969-1970 and 1973-1975. War sentiment has given way to macro policies and corporate profits.

The Gulf War provided the clearest example of "economic transmission". Oil prices soared after Iraq invaded Kuwait in August 1990, and the S&P 500 bottomed out on expectations that the U.S. economy would slip into recession. After multinational forces bombed Baghdad in January 1991, oil prices fell back to pre-war levels, and the stock market rebounded simultaneously. During the war, the Dow and crude oil prices moved almost perfectly inversely—the market traded the trade-off between inflation and growth.

The 2001 war in Afghanistan and the 2003 war in Iraq further verified this rule. Nothing was more symbolic than the killing of Osama bin Laden in May 2011, which was supposed to be the most groundbreaking moment of the war in Afghanistan. The next day, the Dow Jones Industrial Average fell just 0.02% and the S&P 500 lost 0.18%. The market almost completely ignored the news.

In summary, the U.S. stock market’s response to the war has gone through a clear evolution path: from “emotional dominance” to “economic transmission.” Early wars directly shook the market through news of victory or defeat. Since the Korean War, the stock market has paid more and more attention to real economic variables such as fiscal expansion, inflation expectations, oil price fluctuations and monetary policy.

The war itself is no longer the reason for the rise and fall. How the war affects growth and costs is the real pricing object of the market.

Which industry makes money in war? The answer is changing

During World War II, coal was the lifeblood of the war. The proportion of bituminous coal increased from 43.8% before the war to 48.9%, and the industry increased by 415%.

During the Korean War, oil took over and became the new protagonist. Crude oil extraction and processing took the top two places in terms of growth, and revenue continued to rise from mid-1950 to the first half of 1952. The Vietnam War, the disintegration of the Bretton Woods system forced a devaluation of the dollar, OPEC was allowed to raise prices to compensate for losses, and the oil extraction industry exploded into a dollar crisis from late 1970 to early 1973, with gains as high as 1,378% throughout the war.

The Kosovo War continued this pattern, with the raw materials and energy industries benefiting the most.

The Gulf War is the only counterexample - the transmission path shifts to the indirect model of "oil prices → economic expectations". The must-have consumption and health industries dominate in the short term, while heavy asset industries such as energy, raw materials, and industry perform at the bottom.

A noteworthy trend is: As the U.S. economy expands, the military industry has changed from a growth engine to the economic fundamentals. The marginal contribution of a single war to the total continues to decline, and the driving force of the stock market is increasingly giving way to macro variables such as inflation, interest rates, and fiscal deficits.