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Of War and Fortunes

What investors should do in portfolios during war.

Bottom Line up Front: Absolutely nothing!



The specter of war and conflict, whether confined to local arenas, regional theaters, or reverberating across the global stage, invariably instills a palpable sense of apprehension among investors. From the initial tremors of the Ukraine crisis to the geopolitical jousting between heavyweight contenders like the US and China, followed by the Afghan imbroglio, and most recently, the resurgent tensions in the Israel-Palestinian saga (which as of this writing, now more definitively involves Iran), the past few years have unfolded a tapestry of geopolitical events with pronounced resonance. Such episodes cast a long shadow of uncertainty, prompting investors to grapple with heightened volatility in financial markets.


War ≠ Negative Returns

The art and science of wealth management hinge upon an empirical understanding of market dynamics, leveraging historical precedents to glean insights into how markets navigate turbulent waters. While history seldom repeats itself verbatim, its echoes often reverberate in the patterns discerned across time. This evidence-based approach affords a nuanced perspective, enabling us to contextualize contemporary events within the broader tapestry of market behavior. Intuitively, one might surmise that wars and conflicts exert a disproportionately adverse impact on financial markets, heralding disruptions akin to seismic shocks. However, the market's response to such events often defies conventional wisdom. Contrary to expectations, many conflicts, both minor skirmishes and large-scale conflagrations, have wielded minimal influence on underlying market fundamentals or prevailing trajectories. Surprisingly, instances such as the Second World War witnessed financial markets rallying amidst the turmoil, underscoring the paradoxical resilience exhibited amid adversity.


A comprehensive study conducted by LPL Research, spanning 21 geopolitical upheavals since 1941, including seminal events like the Pearl Harbor attack and the 9/11 cataclysm, reveals a pattern of market reactions. On average, markets experienced a modest decline of -1.2% on the day of the event, followed by a trough of approximately -5%, typically reached within 22 days, yet rebounding within 47 days on average. Similarly, research by the CFA Institute illustrates that major wars since 1926 have seen stocks outperforming their historical averages, with large-cap stocks yielding returns of 11.4% and small-cap stocks delivering 13.8% during wartime.

Such findings challenge conventional wisdom, suggesting that wars, paradoxically, tend to be inflationary and conducive to market growth—an intriguing confluence of factors. Even recent conflicts, such as the Ukraine crisis and the Israel-Palestinian turmoil, witnessed transient market dips followed by swift recoveries, emblematic of the market's resilience amidst geopolitical turbulence.


Source: CFA Institute, Bloomberg

Doing nothing is a positive tailwind for returns

However, amidst the ebb and flow of geopolitical vicissitudes, it is not war per se that poses the gravest threat to markets, but rather the specter of uncertainty. Markets, functioning as efficient pricing mechanisms, strive to assimilate all available information in real-time, serving as barometers of sentiment and economic fundamentals. Consequently, escalating geopolitical tensions engender a climate of uncertainty, exacerbating market volatility and prompting investors to seek refuge in traditional safe havens.


Traditionally, assets like US government bonds were deemed sanctuary assets during times of crisis. However, evolving fiscal dynamics, coupled with shifting global economic paradigms, have eroded the perceived sanctity of these havens. Similarly, currencies and commodities once considered bastions of stability now confront their own challenges amidst tepid global demand and shifting economic dynamics.


Yet, despite the dearth of apparent alternatives, markets are dynamic entities, susceptible to paradigm shifts and unforeseen catalysts. The recent flurry of interest rate hikes underscores this fluidity, hinting at evolving market dynamics and recalibrated risk perceptions. Nonetheless, the market's efficiency in assimilating known variables into current valuations offers a semblance of stability amid uncertainty.


Uncertainty = Opportunity for patient investors

Looking ahead, as geopolitical tensions unfold, markets are poised to navigate the labyrinth of uncertainty, recalibrating valuations and risk perceptions in real-time. History serves as a beacon, illuminating the resilience of equity markets amidst conflict, while also underscoring the pivotal role of policy responses in shaping market trajectories. In an era marked by dwindling safe havens, markets remain adaptive, poised to seize opportunities amid adversity, albeit with a discerning eye on unfolding geopolitical dynamics and their ripple effects across global economies.




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