Gun violence on the stock market

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Recently, Market Watch published an article outlining the stock reactions of gun manufacturers on the violence in Las Vegas that took place on the 1st of October. Stock prices of these companies rose sharply after the incident, with American Outdoor Brands Corp. (AOBC) increasing 3.0% during the rest of the trading day and firms such as Sturm Ruger & Co. Inc. (RGR) and Vista Outdoor Inc. (VSTO) gaining 2.7% and 1.8%, respectively. The article suggests that this reaction can be explained by the relationship between the demand for guns and a fear of increased regulation. When customers expect new legislation to make the purchase and ownership of fire-arms more difficult, they decide to quickly buy while they still can, consequently boosting gun sales and share prices. Obviously, events of gun violence tend to spark fears of tighter regulation. This pattern was also to be found after the mass shooting in an Orlando Nightclub on the 12th of June 2016. On the Monday morning after the incident, AOBC opened 8.89% higher than the Friday close, while RGR was up 11.19% and VSTO 2.75%. To further exemplify this trend, the article also noted that the aforementioned companies all experienced a notable decline in sales after the election of President Trump, which apparently reassured the public’s easy access to guns.

A quick look at how sales figures for the last two years compare to stock price evolutions gives further support for this reasoning. In 2016, there were record-high sales of firearms in the US, with over 27 million guns being sold. A possible explanation for this observation is Hillary Clinton’s campaign, which focused on implementing tighter regulations. Although stock prices (see graph at end of article) do not show a clear upward trend such as the one following the short term sales peak, the graph does show a sharp decline in the stock prices from AOBC and RGR after the definitive elections results were announced. The record-high 2016 sales were followed be a strong decrease in 2017, with sales in the second quarter for American Outdoor falling 38% compared to the same period the year before, while Sturm Ruger & Co and Vista Outdoor also experienced double digit declines.

This pattern and explanation seems a bit odd. As the stock prices should incorporate the expectation of all future cash flows of a company, these kind of reactions are rather short-sighted, and one would rather expect stock prices to decline. In the short term, the firms’ sales figures will rise, but this will be offset by a larger decrease in future sales when the tighter regulations actually come into effect. The example of Australia in the 1990s provides support for this statement. After a mass shooting in 1996, the government enacted a very strict gun regulation, which made it harder to buy new weaponry. The proportion of households possessing at least one firearm in the country subsequently declined from 16% in 1994 to 8% in 2000. This was a permanent decrease, as these numbers were 8.7% and 6.2% for 2003 and 2005, respectively. Compare this to the boost in US gun sales after the 2015 San Bernardino, California mass shooting. The increase in sales lasted about 6 to 8 weeks, representing less than 10% of handguns sold every year. Clearly, the decrease in ownership after tighter regulations, which logically has to follow a decrease in sales, has a much larger impact than the short-term sales peak. This shows that an event of gun violence just shifts a small part of future incoming cash flows of the company towards the present. However, one can expect a larger decline in future sales than just this shift in cash flow, as tighter regulations would have a more profound effect on long-term sales. Although the shift in cash flow creates some value from a discounting perspective, this can’t be enough to offset the negative effect of tighter gun regulations in the near future and the big decline in future sales that can be expected to follow. This line of thought would assume that markets are only focused on short-term gains and almost ignore the long-term effects of these events on the industry, an idea that is rather difficult to believe.

Why would the market follow this kind of apparently irrational valuation process then? A possible explanation is that the overall customer base for guns will increase after mass shootings due to people’s decrease in their general feeling of safety. It is reasonable to assume that after hearing about such lethal events, people believe the world is becoming an increasingly dangerous place and want to purchase something they think they can protect themselves with. The data on the table to the left supports this argument, with 48% of people stating protection as the main reason to own a gun in 2013. The importance of this rationale has risen 22 percentage points since 1999, a large increase from a previous 26%. The long-term sales peak we saw in 2016 can therefore be attributed to the heightened terror threat. The big difference with the aforesaid idea is that the reason for the sales peak has nothing to do with the fear of extra regulation, but with fear for safety. So this explains an increase in sales on the short-term for the gun manufacturers, without the accompanying decrease in long term sales implied in the assumption of tighter future regulation. As a result, the value of the firms would undeniably increase and the sudden rise in stock prices is justified in a sound way.

Evidently, the effect on gun share prices after a mass shooting is caused more by the expectation of an increase in sales due to fear for safety than fears of tightening regulation in the near future. The possibility of new legislation that places limits on the sales and use of firearms can be considered to be a potential risk rather than a positive factor for investors in gun manufacturers in the long run. As the stock price reactions show in practice, the market seems to regard this risk as not realistic or important enough to offset the beneficial effect of the extra sales that can be expected in the short term. Therefore, most investors don’t believe that strict regulations will be enacted any time soon, although about 55% percent of Americans in 2016 felt that gun laws should be stricter. Given the current administration in the White House, chances are slim that the majority will get what they want.

Sources: marketwatch.com, cnn.com, bloomberg.com, nydailynews.com, statista.com, reuters.com


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