The U.S. Stock Market in the Era of War

Political  Calculations
Posted: Sep 07, 2014 12:01 AM

The U.S. Stock Market in the Era of World War I

Coming over a century after many of the original events, we thought it was about time we got around to revisiting the history of the S&P 500, or rather, its predecessor indices and components, during the era of the First World War.

Our table below presents an overview of the market from January 1912 through March 1925, showing how the market's price per share, trailing year earnings per share and trailing year dividends per share evolved throughout what might be described as a series of very disruptive events:

S&P 500 Predecessor Components Price per Share, Trailing Year Dividends per Share and Earnings per Share, January 1912 - March 1925

The table below indicate the key milestones of the period:

Timeline of Major Events for the U.S. Stock Market, January 1912 through March 1925
Event Date(s) Description
January 1912 End of January 1910 - January 1912 Recession
A 5 November 1912 Woodrow Wilson elected as U.S. President.
B January 1913 through January 1915 U.S. enters into economic recession.
C 3 February 1913 Delaware becomes 36th state to ratify 16th amendment to U.S. Constitution, permitting a national income tax. Although the Revenue Act of 1913 implementing the U.S. income tax would not become law until 3 October 1913, it was understood that all income earned in 1913 would be subject to the new tax, which would come due on 15 March 1914. The combination of the imposition of the new income tax and how it was implemented is the proximate cause of the 1913-1914 recession.
D 23 December 1913 President Wilson signs the Federal Reserve Act into law. Sidenote: U.S. exports in 1913 total approximately $2.495 billion. Average export surplus (value of exports above imports) during previous 10 years ranges between $400 to $500 billion per year.
E 28 July 1914 Following the assassination of Archduke Franz Ferdinand one month earlier, Austria-Hungary declares war on Serbia, marking the official start of the First World War (a.k.a. "The Great War" or "World War I"). In response, the U.S. suspended all trading on the New York Stock Exchange for four months beginning on 31 July 1914 (until 28 November 1914) and declared its neutrality in the war on 1 August 1914.
F 16 November 1914 The 12 regional banks established by the Federal Reserve Act start operating. Side note: demand for food and materials from Europe began to increase significantly during these first months of World War I.
G 7 May 1915 A German U-boat torpedoed the S.S. Lusitania, killing 1,198 people, including 124 U.S. citizens.
H September 1915 A year after World War 1 began, inflation begins to surge in the U.S. economy as U.S. banks begin to monetize the large quantities of gold that European nations were moving into U.S. banks to both protect them from the conflict and to pay for U.S. exports, since the U.S. was operating under a gold standard. The recently established Federal Reserve lacked the means to offset the inflationary impact, with the resulting effect being that inflation spiked upward from nearly 0% at this time to reach a level over 20% by mid-1917. Inflation would continue at or near that elevated level through mid-1920.
I 24 March 1916 The S.S. Sussex was torpedoed without warning by a German U-boat, initiating a threat by President Wilson to break off diplomatic relations with Germany.
J May 1916 Fearing the U.S. would enter into the European conflict on the side of the Allies (Great Britain, France, Italy, Russia), Germany suspends its unrestricted U-boat campaign.
K 8 September 1916 All U.S. income tax rates are doubled with the top rate set to be 15% for income over $2 million on 8 September 1916 as the U.S. begins gearing up to enter into World War I by passing the Emergency Revenue Act. Side notes: Observe that stock market earnings begin falling sharply in January 1917, while the market's more insulated dividends would begin to fall a year later. Neither will begin to recover until December 1921.
L 31 January 1917 Growing desperate for victory, and fearing that the U.S. is preparing to enter the war on the side of the Allies following President Wilson's re-election in November 1917, Germany resumes its unrestricted U-boat campaign on commercial shipping in the Atlantic Ocean.
M 3 February 1917 The U.S. severs diplomatic relations with Germany as the U.S.S. Housatonic is sunk by a German U-boat. A month afterward, the U.S. learns of the "Zimmerman Telegram", which promises Mexico the return of territory it ceded in the Mexican-American War if it joins with Germany.
N 6 April 1917 Following the sinking of the S.S. Aztec on 1 April 1917, President Wilson delivers a war message to Congress on 2 April 1917, which declares war against Germany.
O 3 October 1917 The U.S. sharply hikes income taxes to support its war efforts. The top income tax rate is set at 77% for income over $1 million and expands to include 56 brackets for all income earned in 1917. Side note: Through the end of 1917, the U.S. export surplus reaches $3.5 billion - approximately 7-9 times its pre-war level.
P August 1918 through March 1919 The U.S. officially enters into recession, as its exports to warring nations in Europe are no longer able to offset its tax-hike driven economic deterioration.
Q November 1918 Germany's Kaiser Wilhelm II abdicates on 9 November 1918 and a Germany signs an armistice to end fighting on 18 November 1918. The war officially ends when the Treaty of Versailles is signed on 28 June 1919.
R January 1920 through July 1921 The U.S. enters into a deep recession as the Federal Reserve acts to bring the high rate of inflation in the U.S. economy under control by sharply reducing the U.S. money supply.
S 23 November 1921 The U.S. reduces income tax rates significantly with the passage of the Revenue Act of 1921, with the top rate reduced to 58%. Stock prices begin to rise in anticipation of the tax rate reductions in August 1921, with stock market earnings and dividends following suit in January 1922.
T May 1923 to July 1924 The U.S. economy enters into a mild recession.
U 2 June 1924 The Revenue Act of 1924 once again reduces U.S. income tax rates, this time setting the top income tax rate to 46%.

The Market in Motion During World War I

Today, we're going to go through something of a data visualization exercise, as we test drive a new online app ( for animating images. Starting with the historic monthly stock price data, trailing year dividends and earnings per share data for the predecessor indices and components of the S&P 500 that we recently featured, and also inflation during that era, we've calculated the year-over-year growth rates of each, which we're presenting in the animated image below, showing each with a four second delay.

Animated Charts: Growth Rates of S&P 500 Predecessor Component Stock Prices, Trailing Year Dividends per Share, Trailing Year Earnings per Share and Inflation, January 1912 through March 1925

Since we now have the year-over-year growth rate data for stock prices and trailing year dividends per share, we wondered if we would observe the same phenomenon with the changes in these growth rates that we previously observed with much more recent data from a century later, where changes in the growth rate of stock prices are directly proportional to changes in the future growth rate of trailing year dividends per share, which primarily vary according to particular points of time in the future.

The following animated chart shows our results, as we shift the change in the growth rate of the stock market's trailing year dividends per share forward in time at 3 month intervals every three-quarters of a second until they reach a point where the change in dividends is positioned 12 months in the future, and back again.

Animated Chart: Changes in Year Over Year Growth Rates of S&P 500 Predecessor Component Stock Prices and Trailing Year Dividends per Share, Shifting Dividend Data by 3-month Intervals to 12-months Earlier and Back Again, January 1912 through March 1925

We find that the stock prices of a century ago work pretty much the same as they do today, with investors periodically shifting their forward-looking attention anywhere from 3 to 12 months into the future when making the investment decisions that ultimately set stock prices. The only major difference in the math is that the amplification scale factor would appear to be slightly different over most of the period, and considerably different for the period where the dividends expected to be paid in 1918 were affecting the stock prices of the latter half of 1917.

The downside with the historic data is that we don't have any dividend futures data to really be able to determine what the expectations for the future looked like during this time. The closer correlations that we observe between the changes in the growth rates of stock prices with the changes in the growth rate of trailing year dividends per share expected at different points of time in the future then really represent the situation where the future played out as investors expected.

There are also a couple of short term noise events that really stand out. The first is in April 1916, where we observe the change in the growth rate of stock prices drops well below where expected future dividends would place them, which corresponds to the sinking of the S.S. Sussex, which was shortly followed by President Woodrow Wilson's threat to sever diplomatic ties with Germany. When Germany suspended its unrestricted U-boat campaign shortly afterward, it avoided the U.S. entry into the war, which accounts for the large upward spike in the month afterward.

The other noise event was more positive in nature, coming when the Armistice ending the fighting in Europe was reached in November 1918, which coincided with an upward spike in stock prices. Alas, being a noise event, it was a short-lived affair before investors returned their focus to their more fundamental concerns, where the combination of ongoing highly elevated inflation and falling earnings became dominant.