How Wars Affect Stock Market Returns: Lessons from History and Current Conflicts
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Reading time: 8 minutes
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Introduction
Our personal finance blog helps you build improve financial literacy and achieve early financial independence (FI) using effective investment strategies. Pursuing financial independence involves saving diligently and investing wisely so you can eventually reach the “crossover point”, where you can live off your investments and, if you choose to do so, quit your job to retire early. Most people achieve financial independence by the traditional retirement age, relying on a combination of pensions, savings, and investments to fund their lifestyle. However, with strategic planning, financial independence can be achieved much sooner.
Understanding Stock Market Volatility on the Path to Financial Independence
For many of us, the journey and the timeline to reaching financial independence depends significantly on the returns generated in the stock market. One of the key challenges we face as retail investors during this journey is dealing with the stock market’s strong volatility. Stock market prices represent the present value of companies’ expected future cash flows, based on investor expectations of a company’s future earnings and growth potential, factoring in risks, interest rates, and market conditions. And, of course, these factors are being evaluated on a daily basis, leading to substantial price volatility. For many investors, it is not easy to just sit there and watch your portfolio go up and down by several thousands of dollars in a short period of time.
Certain market events are more manageable for investors than others. Consider, for example, when the S&P500 goes down several percentage points in response to a Fed’s interest rate policy change that seeks to control inflation. This type of stock market decline may feel less scary to us, because we understand that it is part of a rational decision and part of a normal business cycle. While high interest rate environments certainly do not make it easier for companies in relation future expected earnings or growth potential, this type of market volatility does not feel “disruptive” to the average retail investor. I think most of us sleep relatively well at night during this type of events.
In contrast, consider the first months of the global Covid pandemic, where the S&P 500 experienced a 34% drop from its peak between February and March 2020. The drop was triggered by growing concerns over the global economic impact of the pandemic, lockdown measures, and uncertainty about how long the crisis would last. Many investors would see their portfolios drop by several hundreds of thousands of dollars, and the uncertainty and unprecedented nature of it all would certainly have keep most investors awake at night.
How War and Conflict Events Impact Stock Market Stability
Today, we turn our attention to examine based on historical evidence and past market trends how the stock market typically responds during times of conflict and war. Unfortunately, today we are witnessing the proliferation of high-profile, regional-level international conflicts and wars that hold the potential to destabilize the current global order and send shocks throughout the global economy. Conflicts like the war in Ukraine or the ever-increasing escalation observed in the Middle East between Israel and Iran and its allies are terrible events in terms of loss of human lives. While we acknowledge the human tragedy of these conflicts, in today’s post we are focusing exclusively on how war and conflict events affect stock market volatility and returns.
My original idea was to perform a small literature review on this topic, drawing from and condensing existing literature reviews and meta-analyses. However, during my search I found that the Rational Reminder had already done exactly that. Given the excellent introduction they provide on this topic, we will use a lot of their findings to address some of the questions we have:
What happens to the stock market when a war breaks out?
What happens to the stock market throughout the war?
What happened to the stock market over some of history’s recent major wars?
Are there any types of investments that go up during war?
What happens to bond investments during times of war?
Does it make sense to change your investment strategy when conflicts occur, i.e., can you time the stock market during times of war?
Given the global uncertainties we observe today, my hope is that this post may shed some light on some of these important questions and allow us to sleep a little bit better at night.
How War Affects Stock Markets: Historical Lessons, Market Reactions, and Investment Strategies
What Happens to the Stock Market When War Starts?
During the initial phase of a war, which sometimes occurs by surprise, markets typically react with a sharp decline. The outbreak of WW I represented a major surprise that caught investors (and everyone) completely off-guard. There was a dramatic drop of stock prices when the war begun. For instance, the Dow Jones Industrial Average (DJIA) dropped by roughly 30% during the second half of 1914. This steep decline was a direct reflection of the significant uncertainty and panic that was caused by the unexpected outbreak of the war, which led to a liquidity crisis in financial markets.
Historically, wars increase perceived uncertainty amongst market participants. Markets tend to experience sharp declines initially as investors react to the unpredictability of war. In some cases, though, e.g., the ongoing Russia-Ukraine war, these initial market drops can be followed by rapid recoveries, underscoring the increased market volatility observed in wartime periods.
How Does a War Affect Stock Market Returns?
Considering the entire period of the war, stock market performance depends on the region considered and a given country’s involvement. Historically, individual country markets that were directly involved and lost often saw very substantial losses. For instance, during WW I German stocks lost more than 90% between 1914 and 1922 (in real US dollars), whereas in WW II, German and Japanese stocks lost 90% and 99% of their value, respectively, over the 1939-1947 period. In contrast, US and UK markets delivered mixed results over these two major events: in WWI, US and UK local investors (i.e., those invested exclusively in their country market) experienced a loss of 18% and 17%, respectively, while over WWII markets delivered a positive real return of 22% and 34%, respectively.
What about investors who were internationally diversified? While diversification can mitigate risk during periods of conflict, it is certainly not a guarantee against losses. Consider, for instance, that globally diversified investors saw real losses of 31% and 15% during WWI and WW2, respectively. However, although wars cause certainly increased volatility and short-term losses, global markets have been relatively resilient over the long run. All things considered, despite these short term losses, you’d probably still sleep better at night with a globally-diversified portfolio if a major global conflict broke out. The examples above showcase how damaging it could potentially be to be fully invested in any single country market.
Left to Right, British Prime Minister Winston Churchill, President Harry S. Truman, and Soviet leader Josef Stalin attending the Potsdam Conference towards the end of WWII. Source: U.S. National Archives and Records Administration
What Did the Stock Market Do During WWII?
Initially, during WW II, markets in countries like the US and UK observed modest stock market declines. As the war progressed, though, both US and UK investors would see the tables turn–both earned positive real returns of 22% and 34%, respectively, throughout the war. In contrast, losing countries like Germany and Japan saw their stock markets wiped out. Germany’s market lost 90% of its value by 1947, while Japan lost almost 99%. Interestingly, both rebounded very strongly after the war, albeit at different rhythms: incredibly, the Germany market achieved an average annual return of around 61% during the 1949-1959 period, and by 1952 an investor who had held onto their investments since 1939 would have almost tripled their original investment. This is of course very theoretical, since most people would have been focused on basic survival rather than holding on to stocks. Nevertheless, the potential for a strong rebound after a war is an important observation to be aware of.
How Did the Vietnam War Affect the Stock Market?
During the Vietnam War, the US stock market experienced periods of volatility, but in general the market was relatively resilient. At first, markets dropped as the war escalated, but considering the overall period as a whole the markets performed moderately well, presenting average returns of around 7%. This highlights that major geopolitical events often have less influence on long-term market performance than anticipated–the market’s response to conflict is complex and not necessarily a predictor of poor returns. Additionally, the war led to increased government spending and rising inflation rates, which contributed to market volatility. However, investors' confidence in ongoing economic growth and industrial expansion in sectors like defense helped maintain steady long-term returns.
How Did the Cold War Impact Financial Markets?
Stock market returns in the US during the Cold War period (1948-1989) showed a general upward trend, with substantial period of volatility related to geopolitical tensions and economic policies. The S&P500 experienced an average annual return of approximately 10% during these decades. These returns were influenced by several factors, for instance increased government military spending, economic growth, and advancements in technology and industry. Key geopolitical events like the Cuban Missile Crisis did present temporary market disruptions, but the broader market proved resilient, benefiting from the stability of U.S. economic policies and consistent capital investment in industries like aerospace, defense, and technology.
How Does the War Between Russia and Ukraine Affect the Stock Market?
At first, the market reaction to the Russia-Ukraine war was a sharp decline due to the uncertainty and to geopolitical tensions. However, as mentioned in the Rational Reminder, global markets demonstrated resilience during the ongoing conflict. Similar to other conflicts, throughout the war there has been heightened volatility, with both sharp declines and dramatic recoveries, though of course the long-term effects on markets will depend on the war’s development and outcome, which as of October 2024 is very uncertain.
Which Investments Increase in Value During Wars and Conflicts?
Aside from defense stocks, certain commodities, particularly oil and gold, often see price increases during war. Investors often view these assets as safer havens during volatile times or hedges against uncertainty. Bonds, which are typically considered safe assets, may not always perform well during war, as historical examples show. German bonds lost all their value during WWI due to hyperinflation, and US long-term government bonds lost 67% of their real value during WWII. This is a very surprising result, considering the positive performance of stocks over the same period mentioned earlier. In any case, as emphasized by the Rational Reminder, this doesn’t mean that you should sell all your bonds from a balanced portfolio during times of volatility; what it likely does mean is that it is not a good idea to sell all your stocks and buy bonds thinking they may be safer during these disruptive events.
In relation to stocks, smaller sectors like US small-cap value stocks have also outperformed broader markets during WWII, with an annualized 12% from 1939-1947. Stocks in sectors like energy, healthcare, and commodities also tend to do better during conflicts due to increased demand for their products and services.
Can You Time the Stock Market During Times of War?
One of the key takeaways from the Rational Reminder’s analysis on the relationship between war and stock market returns is that timing the market during times of war is likely a looser’s game–the same outcome as you would expect from trying to time the market during times of peace! Although there may be the expectation that war may lead to a market drop, historical data shows that markets are often unpredictable, with paradoxical rises in stock prices even during war time. Therefore, a portfolio’s risk management should take place prior to this type of events, not while they are occurring. Two final takeaways for me were also 1) the importance of an internationally diversified portfolio to minimize risk exposure from this type of events, and 2) it is important to remember that the largest stock market crashes historically took place during peace time (e.g., 1929, 1973 oil shock, 2008 financial crisis), not periods of war.
Enjoyed this post? Don’t miss Jack Bogle’s 14 tips for common sense investing or Morgan Housel’s 18 money lessons based on his bestseller ‘The Psychology of Money’.
