How Did the US Stock Market Perform During the 1918 Spanish Flu Pandemic?

During the 1918 Spanish Flu Epidemic, the first wave of deaths hit its peak of 5 deaths per 1,000 persons in July of 1918. It subsided in August and remained that way for the rest of the summer. Come Fall of 2018, a second and much more lethal wave hit, peaking just below 25 deaths per 1,000 persons in November of 2018. This wave subsided to more normal levels during winter. Then a third wave of deaths hit in February of 2019, lasting until May of that year. About 28% of the US population were infected during this period, leading to an estimated 500,000 to 675,000 deaths (0.48 to 0.64% of the population).

Surprisingly, the stock market during this time period remained remarkably stable. It did not crash. The Dow Jones Indusrial Average Index (DJIA), which was the only US stock market index to exist at that time, shows that the market remained relatively flat throughout 1918 and then soared by almost 50% by the end of summer of 1919.

The DJIA is a price-weighted index that measures the stock performance of the 30 large companies listed in the US stock market and is therefore not representative of the broader market.

The S&P 500 Index is broader-based stock market index because it includes at least five hundred of the largest publicly listed companies in the United States. The S&P 500 is a capitalization-weighted index and not price-weighted. It is constructed by combining the market capitalizations of all the component companies. However, the S&P 500 Index only came into existence in 1957. It did not exist in 1918. So how do we gauge the broader market performance of that time.

Enter Finance Professor Robert Shiller of Yale University has a data set which presents the "US Stock Markets 1871 - Present and CAPE Ratio," which reconstructs or estimates what the S&P 500 Index would have been during the Spanish Flu Pandemic using data on the stocks being traded in the US stock market at that time.

The reconstructed S&P 500 Index showed that the broader stock market did soar not just in 1919 but starting in 1918, when the first wave of the pandemic hit.

So, what gives? Why did it soar?

Simple. The economy soared too. Real GDP soared by 9.02% in 1918, then dropped to a measly growth rate of 0.80% in 1919, according to economists Reinhart & Rogoff.

Why did GDP by 1918 in the midst of a global pandemic? Because the US entered World War I in April 1917 and spent billions on military preparations.

The data from the White House website tells it all.  Government spending soared by 549% in 1918, from just 3.27% of GDP in 1917 to 16.72% of GDP in 1918.

 

Year	Total US Government Revenues and Outlays
	Receipts	Outlays	Surplus or Deficit (-)	Outlays as % of GDP
1914	725	726	-*	1.99%
1915	683	746	-63	1.93%
1916	761	713	48	1.44%
1917	1,101	1,954	-853	3.27%
1918	3,645	12,677	-9,032	16.72%
1919	5,130	18,493	-13,363	23.62%
1920	6,649	6,358	291	7.19%
1921	5,571	5,062	509	6.88%
1922	4,026	3,289	736	4.48%
1923	3,853	3,140	713	3.68%

Source: Whitehouse.gov and Reinhart & Rogoff

The bulk of the increased outlays were for military spending itself. Expenditures soared from just $546 million in 1917 to $7.05 billion in 1918. It drafted 2.8 million men to fight the war in Europe. By the summer of 1918, it was sending 10,000 fresh soldiers to France every day. World War I lasted until November 1918 at the height of the pandemic. When the war ended, so did expanded military spending and GDP growth dropped off considerably.

The economy was kept humming at a brisk pace, unhampered by the lack of quarantines, allowing the pandemic to grow and spread, leading to many more millions of unnecessary deaths. In other words, public health officials did not flatten the curve so as not to cripple the war effort.

Obviously, not flattening the curve today is not possible. It would be political suicide for any government official to let the pandemic run wild.

One obvious lesson we can take away is that massive government intervention, not necessarily in the form of miltary spending, can keep the economy humming, if not soaring, in the midst of a global pandemic. Even Ken Rogoff, known for his hawkish views on government debt, seems to think so.

I mean, there's never been a concern about our government's defaulting. The concern is being able to borrow massively when you need to. That's the whole point of saving for a rainy day. When it rains, you want to really open up the floodgates.

And, here, I just — there's no limit. We're in a war. You have to win the war. I would have no problem with the government debt magically going up $5 trillion in the blink of an eye, if we could get out of this in two or three months healthily.

This is an emergency. You're not worrying about your credit standing right away. I don't think that's going to a problem. And you know what? If we have inflation at the end of this, so what, if that is what we needed to do to win this war. We're trying to protect the American people, protect our interests, protect the future.

This is really — think like World War II, World War I. It's this — tiny little viruses invading us, but you know, make no mistake, this is like a war, an alien invasion.

Maybe we should do the same thing in 2020. Goverment has to step in and pick up the economic slack or we will fall into an economic, financial, and political abyss.