War and the Effect upon Stock Markets: It is a Global Phenomenon

If history is anything to go by, one rule can be applied to the stock market at times of geopolitical unrest and war: conflict is good for equities, but only once investors become convinced that they are on the winning side. Early on it can be a volatile one-way ticket down.

Just keep in mind that old adage:

The market is always right, until it's wrong. Then it can change course in an instant.

The onset of geopolitical troubles has the effect of causing wild volatility, as swings in expectations, from pessimism to optimism, take hold. The potential of escalating geopolitical tensions suggesting war can be a greater negative on the market than conflict occurring.

Korean War

Take the example of the Korean War, which started in 1950. When it became clear that the West would have to go to the aid of South Korea to defend it from communist troops in the north, share prices fell in the US by 13 per cent, and to a slightly lesser extent in London. The uncertainty surrounding the outcome of the Korean conflict may be instructive: there were real fears that hostilities could be a prelude to a third world war that would pit America and her allies against China and the Soviet Union.

Yet, after three weeks of tumbling prices, stocks rallied as it became clear that a third world war would be averted, and that the Korean conflict could be contained. It was the fear that a regional war in Korea could spill into something bigger and more dangerous that spooked world markets.

Remembering 1991

In January 1991, US stocks plunged in anticipation of the Gulf war. Saddam Hussein's threats that Americans would come home in body bags, and that we would fight a long war, led investors to shun the stock market and search for safer havens. The Dow Jones Index (DJIA) had fallen from 3,010 in July 1990 to about 2,600 in December, a 21 percent drop. But literally within hours of the start of the war, it became evident that American missiles could target a single room inside a building, and that our overwhelming air power was causing the Iraqi army to lay down their arms and surrender. The market realised it had been too pessimistic, and the market direction changed sharply. 

The Short-term Lesson

In times of geopolitical unrest, the noise surrounding stockmarkets is disorientating and the compaction of trends that would historically take months or years to form become short-term trading frenzies. 3% swings in index prices in a single day are not uncommon with the hedge funds and day traders short selling shares, or taking long positions driven by the daily war updates. There is simply too much noise and volatility resulting from geopolitical unrest or war to make much sense of global equity markets in the very short term.

Today

The biggest unknown is the Middle East. Will things improve or deteriorate? Will democracy or terrorism grow? This doubt will be a market problem for years to come.

As the above analysis shows, geopolitical unrest at its worst - war - has a short-term influence on markets. This is further supported by historical data surrounding previous conflicts over the past half century.

The major caveat to this view emerges if the conflict spreads regionally, in which case the war is likely to dampen markets for some time to come.

Long-term Investing

Historically, stocks tend to decline during geopolitical unrest, as investors reduce stock holdings into less risky investments. But, as was the case during the Gulf War, global stocks often quickly when a clearer understanding of the end-result appears.

Investing in the stock market is not a two-month or two-year program but rather a long-term plan of five years or more. Modern society has been conditioned to look for instant gratification and results. However, as we have said before, the patient investor is looking for longer term performance. Investors should constantly review their investments. In general companies that have proven management provide better long-term performance results.

Investing in times of geopolitical unrest is far from simple. It's best to stick to the basics: a broadly diversified portfolio of sound, growing companies.