War May Be Bad, But Not for Stocks
Recent rhetoric between US President Trump and North Korea made many investors jumpy. With the possibility of a localised conflict occurring, what would be the impact on investors?
For sure, investors hate uncertainty, and that definitely showed in the markets last week when there was something of a global mini-correction. Without knowing what may happen, investors typically pull money out of the markets first and seek safe havens.
However, many studies have been done which show that war, and even global wars do not have a lasting impact on stock markets. What affects stock markets directly and creates bear markets are only two circumstances:
Recession, and
Financial Crisis.
Other than that, we can take it as part of market volatility and the risk we have to bear to get a return on our capital.
First, lets look at some recent conflicts involving the US military overlaid on a chart of the global stock market. The most recent conflicts are the 1983 Invasion of Grenada, 1989 Invasion of Panama, 1991 Gulf War, 1999 Kosovo Bombing, 2001 War in Afghanistan, 2003 Gulf War and 2011 Libyan Bombing.
You will notice that wars are inconclusive in determining the direction of the stock market. However, what is more telling and more important is the presence of an economic recession or a financial crisis, which is shown with red arrows.
A 2013 study found that the stock market’s average volatility was significantly lower during four major wars of the last century: World War II, the Korean War, the Vietnam War, and the first Gulf War. Large-cap stocks were 33% less volatile during these four wartime periods than across all periods since 1941, while small-cap stocks were 26% less volatile. Logically, when the stock market is less volatile, it tends to trend higher. Large-cap stocks gained 1.4 percentage points more per year during these four wartime periods than the rest of the time, while for small-caps, the margin was 2.2 percentage points.
As such, investors shouldn't even try and guess the direction of the stock market if conflict does erupt in North Korea. We have seen from this that predicting is a futile exercise.
