War & the Stock Market – Are they linked? Part 2

A Socionomic View of War, Stocks and Commodities

By Alan Hall, originally published in the October 2008 Global Market Perspective Download PDF (868 KB)

The principle of Occam’s Razor states that the explanation of any phenomenon is more likely to be correct if it makes as few assumptions as possible. Socionomics makes a single assumption: that endogenous social mood ultimately dictates the character of collective social action.

This hypothesis reverses the conventional direction of inquiry about what causes war. Instead of asking how war affects the economy, stocks or commodities, the socionomist asks, “How do fluctuations in social mood affect the prices of stocks and commodities, the strength of the economy and the likelihood of war?” This non-conventional approach to causality eliminates conflicting assumptions and rationalizations, and provides the simplest explanation of the available data.

Using socionomics’ single assumption, this report examines war’s relationship to the economy, real stock prices and commodity prices.

War and the Economy From 1776 to 2008, United States military forces have been deployed hundreds of times, both abroad and domestically. In this report, we will examine only the major wars that involve the United States.

For many years after World War II, most economists and historians assumed that war, man’s most destructive activity, was good for the economy. A recent quote from Nobel-winning economist Joseph Stiglitz illustrates the popular change of opinion: “It used to be thought that wars are good for the economy. No economist really believes that anymore.”

EWI has always disagreed with this idea and observed that the error arose from incorrect assumptions about what causes war. In 1999, The Wave Principle of Human Social Behavior addressed this:

Major mood retrenchment produces war, as humans finally express their collective negative mood extreme with representative collective action. As with economic output, the size of a war is almost always related to the size of the bear market that induces it.

An initial look at the steady ascent of the U.S. Real Gross Domestic Product — the upper line in Figure 1 — suggests that U.S. economic growth is largely unaffected by its wars, which have mostly been waged elsewhere. Looking more closely at the upper line, we can see downturns in real GDP near the end or shortly after each of the completed wars. In the lower line, the real GDP rate of change showed net slowing during all wars except World War I. Just after World War II, real GDP suffered its second lowest rate of change since at least 1870. The data shows that the economy has usually slowed during war and regressed afterward.

Figure 1 – Click Image to Expand

But the data also show that war did not cause the decelerations. There were no wars prior to the GDP declines that bottomed in 1908, 1933, 1938 and 1982. These declines occurred during Cycle and Supercycle degree corrections in the inflation-adjusted Dow, another measure of social mood (see Figure 2). The GDP declines that followed three of the four completed wars — in 1921, 1946 and 1975 — also occurred during or just after Cycle and Supercycle degree corrections. Socionomics provides a better view of the larger relationship between war and the economy: negative social mood leads to economic slowdowns and, occasionally, war.

War and Stock Prices The graphs in Figure 2 should be familiar to long-time readers. They depict the nominal (light line) and inflation-adjusted (dark line) prices of U.S. stocks (spliced to British data for the 18th century).

We have shaded all bear markets in inflation-adjusted stocks and drawn boxes around periods where war was in progress. You can see that most wars occur either late within or just after bear markets in stocks. This is because the stock market usually responds to declines in social mood more rapidly than societies can prepare for and initiate war. Chapter 16 of The Wave Principle of Human Social Behavior describes the relationship between stocks and war in detail, but for the purposes of this report, it is enough to notice that, much like economic slumps, most wars follow the onset of bear markets, usually erupting late within them or shortly thereafter.

War is expensive, and in order to pay for it governments often levy a tax by stealthily inflating their currencies. The result of inflation is visible in Figure 2, so let’s look at each war in turn. During the American Revolution, the nominal Dow crossed above the real Dow for the first time since the South Sea Bubble in 1720. It remained above it for four years before dipping back below. At the beginning of the War of 1812, the nominal index was above the real index and stayed above it for eight more years. During the Civil War the nominal index broke above the real index and stayed above it for 13 years. Another break above occurred during World War I, just after the Federal Reserve gained control of the monetary system in 1913. This time, the nominal index continued soaring into the credit inflation that preceded the 1929 crash, and then it crossed back below the real index in 1932, during the Great Depression. It lingered there only briefly. Then, as stocks rallied during World War II, the two indexes began to diverge steadily as the Fed and the banking system began their exponential expansion of the money supply. The two indexes have never significantly converged since.

Figure 2 – Click Image to Expand

These two measures show their greatest periods of divergence during the 1966-1982 and post-2000 bear markets. Another change accompanied this increasing divergence: the next two wars in Vietnam and Iraq broke a 230-year pattern by occurring much earlier in the bear market. Government control of the money supply has certainly made war easier to finance, obviating the need for broad-based consent of the governed. Perhaps it has also made ill-considered war more likely.

War and Commodity Prices Figure 3 shows a remarkable correlation between commodity price spikes and wars involving the United States. To begin exploring the relationship, let’s start with a quote from the May 1997 Elliott Wave Theorist:

I contend that major commodity price rises, while similar in profile, do not qualify as manias. The engine of a commodity boom is usually fear (of shortage, war, inflation, etc.), not hope and greed, so the entire phenomenon is fundamentally different. Commodity booms do not necessarily follow long periods of jagged advance, either, but sometimes emerge suddenly from lengthy doldrums.

The current boom in the CRB index emerged from a 21-year bear market that began in 1980 and ended in 2001, just before the war in Iraq got underway, and during a widespread surge in fear of terrorism and climate change. Did the terrorist attacks in 2001 cause commodity prices to rise? A cursory glance at the CRB Index in Figure 2 might make you assume so, but there is more to the story.

Figure 3 – Click Image to Expand

Since the American Revolution, commodity price spikes have occurred during all major wars involving the United States. The beginning of any of these wars was a great time to buy commodities and, in most cases, the ends were good times to sell. A majority of the completed wars were followed by swift commodity price collapses, but there are three notable exceptions: World War II, Korea and Vietnam. The Wave Principle suggests the reason for this difference may be the position of these wars within the CRB’s wave pattern.

Each of the first four wars ended near major peaks in the CRB index and occurred during the terminal wave of a larger price move. Two of them (the War of 1812 and the Civil War) were the final moves in b waves and were followed by swift price collapses that retraced more than the wartime advances. The other two wars (the American Revolution and World War I) occurred during fifth waves, the final moves in impulse patterns. The American Revolution was followed by a 78.77% collapse and World War I by a 67.12% drop. The next three wars, World War II, the Korean War and the Vietnam War, occurred during wave III of (III), the middle wave in the sequence. The price spikes during these conflicts were not retraced, and the bulk of price advance in wave III occurred during these wars.

The waning Iraq war has occurred entirely within a terminal pattern, wave V of (III). As with the other four wars that occurred in terminal waves, we expect the price advance from 2001 to end near the end of the Iraq war and lead to a steep price collapse in wave (IV), a correction one degree larger than that of wave II from 1920-1933. The Iraq war qualifies as a major U.S. war in terms of expense, number of troops, U.S. and allied casualties and a large, undetermined number of Iraqi casualties. Less than 90 days after commodity prices turned down, the U.S. and Iraq are “nearing an accord” that will reverse the Bush administration’s long-held opposition to a timeline for withdrawal. On September 15, General David Petraeus left Iraq. U.S. involvement in the Iraq war is winding down.

The previous wave (II), which bottomed in 1897, took the form of a sideways correction, an expanded flat. The guideline of alternation suggests that wave (IV) will form a sharp correction or a triangle. The first Elliott wave target is the 2001 low of the previous wave IV.

War, Inflation-Adjusted Stocks and Commodity Prices To examine the interrelationship among these three social activities, we combined them in Figure 4, added a correlation study and marked periods of strong deflation with slender shaded rectangles. As in Figure 1, the large, lighter-shaded rectangles mark the inflation-adjusted bear markets in stock prices, which are strongly correlated with bull markets in commodities. This is less significant than it may seem at first, because we use the Producer Price Index – which is quite similar to the CRB – to adjust stock prices for inflation. Nevertheless, the PPI-adjusted stock index is a valid meter of social mood. It represents real purchasing power and reflects the same deep feelings of confidence and fear that move commodity markets.

Since collective mood usually moves these markets inversely, the rare times when they move in the same direction mark the strongest periods of inflation and deflation. The middle line in Figure 4 shows the duration and extent of aligned moves in inflation-adjusted stock and commodity prices.

The correlation study shows that in more than 300 years, there are only eight periods lasting a year or more in which real stock prices and commodity prices move simultaneously downward. The two most severe of these are the aftermath of the South Sea Bubble in 1721 and the Great Depression in 1930-1932. No wars occurred during any of these deflations.

The upward (inflationary) correlations occur in greater number, but the three strongest occurred during what were arguably some of the most intense periods of social polarization in U.S. history. In the War of 1812, settlers fought internally against Native Americans and externally against the British. In the Civil War, brother fought brother in a near-collapse of the nation. During the Iraq War, the U.S. split internally into a highly polarized “with us or against us” political divide. Globally, it weakened relationships with some major World War II allies.

Periods of profoundly negative social mood create major bear markets in real stock prices and strong social polarization. These episodes often begin with a year or more of price deflation and culminate in periods of intense social stress that feature price inflation, war and (although we’ve been spared much of this since post-World War I) famine and disease.

Figure 4 – Click Image to Expand

Some critical observations regarding Figure 4:

  1. All of the completed wars shown on this chart ended during a yearly rise in inflation-adjusted stock prices.
  2. Major peaks in stocks occurred near major commodity-price bottoms. The primary exception is 1835, at the beginning of a major deflation.
  3. Wars and the steepest commodity price spikes usually occur late in stock corrections, when fear approaches its highest level. The exceptions are the Korean and Vietnam wars.
  4. In all wars but Vietnam, bear markets in stocks and bull markets in commodity prices began before the war did. The Vietnam conflict intensified as the bear market progressed.
  5. Wartime commodity price spikes usually end near the end of the war.
  6. Four of the wars were fought during stock bull markets: the War of 1812, the Civil War, World War II and the Korean War. Commodity prices, however, continued to rise. During the Iraq war, stocks have maintained their level of the start of the war.
  7. Bull markets in commodity prices have continued after the end of a war, but there are no examples of major wars that continue for long after a major commodity price peak. Of the seven completed wars in Figure 4, five ended soon after visible price peaks, and World War I ended just before a major price peak. World War II was the lone exception, ending after a slowdown in price advance.

Causality The common assumption is that war causes commodity price spikes. But the socionomic view is different. A trend toward negative social mood creates a bull market in commodities, a bear market in stocks and a greater likelihood of war.

War does not accompany all bull markets in commodities. Economists and others who contend that war “makes” commodity prices rise are left with the question: What caused the fear and war in the first place? A more complete view begins with the understanding that collective social mood generates both periods of confidence that result in peace and periods of fear that lead to war, and that the stock market and commodity prices are sensitive indicators of fluctuations in this mood.

When the Horde Hoards War expresses feelings of being threatened. These feelings are proportional to the degree of negative social mood as indicated by the Wave Principle via stock indexes. If you have lived through a big enough bear market, you are scared and angry enough to attack just about anybody. Commodity price spikes are also driven by feelings of being threatened by depletion or shortage of resources. Such feelings trigger a compulsion to hoard, as noticed by the New York Times in a June 30 headline, “Hoarding Nations Drive Food Costs Ever Higher.” Hoarding increases the potential for international conflict: “Japan and Switzerland are leading a group of food-importing nations so alarmed by restrictions that they are seeking an international agreement preventing countries from unilaterally limiting food exports.” The same mindset leads to trade barriers, historical hallmarks of negative social mood. A fearful social mood, then, is behind commodity hoarding and war.

Utility The socionomic view of the causal relationship between social mood and social actions such as war has been useful in the past. For example — as shown in Chapter 5 of The Wave Principle of Human Social Behavior — Ralph Nelson Elliott’s August 1941 observations of the DJIA allowed him to forecast an imminent bottom. Elliott said the pattern “is well advanced, and its termination … should mark the final correction of the 13-year pattern of defeatism.” Eight months later, in April 1942, social mood bottomed, the DJIA registered its low, and the Allies achieved the first of a series of critical victories that turned the tide in World War II.

Many nations, certainly Israel, consider the U.S. presidential election in November to be a portent of the fate of the U.S.’s wars in Iraq and Afghanistan. Our research suggests that commodity prices are a better indicator of whether the conflicts will continue.

Summary Social mood typically drives the prices of commodities and inflation-adjusted stocks in opposite directions, but not always. The rare deflationary periods of simultaneous price decline in stocks and commodities highlighted in Figure 4 usually occur within A waves in stocks. These precedents are 1805, 1892, 1929, and wave c of a in 1837. (For wave labels, see Figure 16-6 on page 268 of The Wave Principle of Human Social Behavior.) The current wave c in stocks is the final leg of wave (a), the first Supercycle-degree (a) wave decline since 1720. Also important: a major credit deflation is unfolding, and deflation is a well-known prerequisite for depression. The societal embrace of debt has created the ideal conditions for maximum retrenchment. According to the CIA fact book, the U.S. has the worst current account balance on the planet, worse than 187 other countries, a debt almost equal to the total deficits of the other 117 indebted countries on the list. Ironically, Iraq has a surplus, while the U.S. continues to borrow money to wage the war and reconstruct that country.

An indication of government’s role in bringing us to today’s precipice is the steadily increasing divergence between nominal and real stock prices shown in Figure 2. The government’s monopoly of the money supply since World War I is the leverage that enabled today’s astronomical debt levels. If the recent credit expansion is a larger-degree version of the first major experiment with credit inflation in the 1920s, it is quite plausible that, once again, a period of downward alignment in stock and commodity prices is underway. And devastating as it was, the 1929-1933 deflation began with the U.S. in much better fiscal position than its status today as a debtor nation. Today’s juncture seems an excellent candidate for a Supercycle wave (a) deflation.

History suggests that if commodity and real stock prices decline significantly and together within the confines of wave (a), we should expect no major war until after the onset of wave (c). If commodities rally to a new high and beyond, expect a continued bear market in inflation-adjusted stock indexes, a rise in societal stress and a continuation and perhaps expansion of the current conflicts.

Alan Hall writes   for The Socionomist.



Socionomics InstituteThe   Socionomist is designed to help readers understand and anticipate   waves of social mood. We also present the latest essays in the field of socionomics,   the study of social mood; we anticipate that many of the hypotheses will be   subjected to scientific testing in future scholarly studies.

The Socionomist is published by the Socionomics   Institute, Robert R. Prechter, Jr., president. Alan Hall, Ben Hall, Matt   Lampert and Euan Wilson contribute to The Socionomist. Mark Almand,   executive editor. Chuck Thompson, editor.

We are always interested in guest submissions. Please email    manuscripts and proposals to Ben Hall via institute@socionomics.net.   Mailing address: P.O. Box 1618, Gainesville, Georgia, 30503, U.S.A. Phone:  770-536-0309.

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Correspondence is welcome, but volume of mail often precludes    a reply. Whether it is a general inquiry, socionomics commentary or a research  idea, you can email us at institute@socionomics.net.

Most economists, historians and sociologists presume that    events determine society’s   mood. But socionomics hypothesizes the opposite: that social mood determines   the character of social events. The events of history—such as investment   booms and busts, political events, macroeconomic trends and even peace and war—are   the products of a naturally occurring pattern of social-mood fluctuation. Such   events, therefore, are not randomly distributed, as is commonly believed, but   are in fact probabilistically predictable. Socionomics also posits that the   stock market is the best available meter of a society’s aggregate mood,  that news is irrelevant to social mood, and that financial and economic decision-making  are fundamentally different in that financial decisions are motivated by the  herding impulse while economic choices are guided by supply and demand. For  more information about socionomic theory, see (1) the text, The     Wave Principle of Human Social Behavior © 2011, by Robert Prechter;  (2) the introductory documentary History’s     Hidden Engine; (3) the video Toward       a New Science of Social Prediction, Prechter’s 2004 speech before   the London School of Economics in which he presents evidence to support his   socionomic hypothesis; and (4) the Socionomics Institute’s website, www.socionomics.net.  At no time will the Socionomics Institute make specific recommendations about  a course of action for any specific person, and at no time may a reader, caller  or viewer be justified in inferring that any such advice is intended.

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