War is risky business – but a business nonetheless, with economic implications that are far too potent to ignore.
The debate over a strike on Syria for its alleged recent use of chemical weapons against rebel factions has stolen the spotlight at the G20 summit currently underway in St. Petersberg, Russia. That the G20 is an economic forum didn’t make the topic any less fitting, since a strike against Syria – and the almost certain regional war it would trigger – would carry serious implications for the global economic recovery.
Developing nations attending the summit, including China, Russia, India, Brazil, and South Africa, lost no opportunity expressing their concerns over the negative economic impacts of such military action. But truth be told, war does boost certain economic activities, commodities, and businesses.
If your portfolio is not yet prepared for the almost certain upcoming conflagration in the Middle East, you may be wise to make room in it for the business of war.
A Polarized G20
Ever since images surfaced of dead and dying victims of a sarin nerve gas attack in the Ghouta district of Syria’s capital city of Damascus on August 21st, the leaders of several Western nations, including the U.S., the U.K., and France, have been sounding a rallying cry for the international community to mount a punishing strike against the Syrian government of Bashar al-Assad, whom they believe is responsible.
U.S. President Obama stressed the importance of dealing a strike as a deterrent to future uses of chemical weapons by nations or armies who would otherwise fear no reprisals. Obama made the stakes clear: “The international community’s credibility is on the line.”
While the remaining G20 members openly condemned the chemical attack, most were unwilling to endorse any strike against Syria that was not sanctioned by the United Nations’ Security Council.
“We urge the U.N. Security Council to unite to prevent any further chemical attack,” Herman Van Rompuy, president of the European Council, exhorted at a briefing yesterday, as quoted by the L.A. Times.
Yet obtaining the U.N. Security Council’s go-ahead is going to be extremely challenging, with two of its members – China and Russia – opposed to any actions that could escalate into regional war.
It “will definitely have a negative impact on the world economy,” warned China’s Vice Finance Minister Zhu Guangyao, citing International Monetary Fund projections that the conflict could add another $10 to the price of oil, which would in turn erode some 0.25% from global economic growth.
China’s and Russia’s concerns were echoed by India, Brazil, and South Africa, who all share a kinship as the BRICS group of developing nations.
“It was noted within BRICS dialogue that among the factors that could negatively affect the global economic situation are the consequences of the eventual foreign intervention into Syrian affairs,” Reuters cites Dmitry Peskov, a spokesman for Russian President Vladimir Putin. “Such consequences can have an extremely negative effect on global economy.”
War’s Economic Implications
The destructive implications of war on an economy are easily understood. Depleted reserves of cash, food, and fuel, plus the loss of a large percentage of the workforce through death and disability, can leave nations devastated if not bankrupt. As a result, many a revolution have been triggered by the turmoil of war, such as Russia’s in 1917 toward the end of World War I.
Wars can also sew the seeds of future conflicts as the vanquished vow their revenge, as in the rise of the Nazis, which ultimately triggered the repeat conflict of World War II.
Yet economists and politicians will just as adamantly stress that war can sometimes bail certain countries out of terrible economic depressions, as the Second World War did for the U.S., the U.K., and a whole host of their allies.
20th century economist John Maynard Keynes wrote to U.S. President F. D. Roosevelt in 1933 that “war has always caused intense industrial activity,” as cited by New Deal Documents. “In the past,” Keynes references, “orthodox finance has regarded a war as the only legitimate excuse for creating employment by governmental expenditure.” (That is, of course, until Q.E. came along.)
Although the positive economic implications of war have come to be known as Military Keynesianism, Dr. Keynes was not advocating war in his letter to the President. He was, instead, advocating borrowing to pay for public works – that the government take out loans and spend its way out of the depression. He merely referenced war as the only other known means of spurring economic growth.
War stimulates an economy as the government ramps up its war machine and goes on a shopping spree for food, clothing, arms, and transportation. It builds factories and drives production. It recruits soldiers and other personnel, putting people to work. It even lays the groundwork for innovation in science and technology, giving us such inventions are radar, wireless phones, jet engines, computers, and even the Internet.
It is not like me to be so cynical. But if the five-year-old economic crisis that has paralysed the globe is comparable to the Great Depression of the 1930s, then perhaps the only thing that will get us out now is what got us then… a world war.
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Investing for the War
As investors, we may as well skip beyond the debate over a Syrian strike and focus on the economic impact of a regional war in the Middle East. Let’s face it… Syria will not only be struck; it will be attacked, as the third and final stepping-stone to the ultimate target – Iran’s nuclear facilities. Afghanistan and Iraq were the first two steps, conveniently bordering Iran. Syria is not so much a military target as it is political target to draw allied Iran into war.
Let’s not be naïve about it – there will be war. So let’s just prepare for it.
The chart below shows how crude oil, gold, and equities have been reacting to all the talk on a possible strike against Syria over the past 10 trading days from August 23rd to September 5th.
(Substituting for oil is United States Oil ETF (NYSE: USO) in black; for gold is SPDR Gold Trust ETF (NYSE: GLD) in beige; for equities is SPDR S&P 500 Trust ETF (NYSE: SPY) in blue. Click to enlarge.)
On Monday, August 26th, when U.S. Secretary of State John Kerry addressed the U.S. position favoring a strike on Syria, oil and gold surged, while equities fell. Then, from Wednesday the 28th, as opposition to a strike grew across the international community, both oil and gold starting giving back some ground, while equities slowly improved.
From this, we see that the prospect of war adds a premium to the prices of oil and gold. In oil, there is the anticipation of increased consumption and decreased production due to supply-line interruptions. In gold, there is the anticipation of currencies under pressure as commerce falls and national debt rises.
However, equities follow the inverse trend of reeling on the anticipation of war and then rallying on the event. As a recent example, the invasion of Iraq in March of 2003 marked a turning point in U.S. equities, officially ending the 2001-03 correction and mounting a stellar rise for over five bumper years until the housing crisis.
For equities, the uncertainty of war is more detrimental than war itself. Once the uncertainty is removed, investors know where to put their money, and the markets take off.
Yet we still need to anticipate which sectors of the equity market will outperform the rest. Obviously, any company that generates income from wartime activity will benefit most. These include defence contractors, such as Lockheed Martin Corp. (NYSE: LMT), Northrop Grumman Corp. (NYSE: NOC), and Boeing Corp. (NYSE: BA). Plus oil producers, such as Exxon Mobil Corp. (NYSE: XOM) and a whole host of petroleum companies.
Just don’t leave out basic consumer stocks, such as retail stores, clothing, and electronics. War employs more workers, which gives them spending money that moves into every corner of the economy.
If simplicity is your comfort, you can easily protect your portfolio from the ravages of war with those very three ETFs in the graph above – USO for oil, GLD for gold, and SPY for equities. If you hold any Middle Eastern stocks or currencies, though, seriously reassess their weighting, as the risk in such holdings has greatly increased.
Economists now need to reassess everything. Any sign of war may force the U.S. Federal Reserve to rethink its bond buying exit strategy and timing. Stimulus may not be on the way out anymore. The landscape has changed; our maps are now outdated. From here on out, we need to plot a new course.
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