War and Its Impact to Markets
Key Takeaways
While geopolitical crises usually cause a short-term reaction in stock and bond markets, it is usually short-lived with markets recovering quickly. (Unless it coincides with a recessionary period)
Financial markets and economic growth are influenced more by long-term trends and cycles instead of crises, events, or even wars — this is true for both stocks and bonds.
The world would not see an end to future conflicts and crises, and unless you are reaching your goal soon, then it is better to ride out the short-term volatility and stay the course.
The future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.
— Warren Buffett
Financial strategists have a rule of thumb; that investors hate uncertainty more than anything. The recent conflict in the Middle-East has brought about this factor into the recent equation, and there are few situations more uncertain than the threat of war.
However, you may be surprised to know that situational uncertainty doesn’t always play out in stocks as many would have you assume. And of course, geopolitical crises can be disruptive to the global economy (and even financial market performance). However a historical study of stock and bond markets shows that while there typically is a short-term reaction to that uncertainty, it is also a short-lived one, and that the markets recover quickly. Essentially, financial markets and economic growth are influenced more by long-term trends and cycles rather than by crisis events.
The chart below shows various crisis events overlaid on the S&P 500 index (which has a longer history than global stock market indices). These crises include wars, terrorist attacks, political coups, and even financial meltdowns. Regardless of the type of crisis, the market is “shocked” in the short-term, but recovers quickly unless the event occurs during a recessionary period (shaded area).
Looking at stock prices on a monthly basis (table below) — on average, the market has been unaffected up to a year after the crises. Post-crisis performance is significantly better when recessions are excluded. If history is any guide, then it is likely that the current conflict — occurring outside of a recessionary period could lead to similar results.
The past outbreaks of wars or geopolitical specific events also tells a similar story. The longest recovery period was only nearly a year during 1941 — where the world and the US in particular was emerging from a recession where peak unemployment numbered nearly 20%.
While most would focus their attention on stocks during times of crisis, what about the impact of wars on bonds? A logical path would be an increase in defence spending (without cutting the budget in other areas) would lead to increased budget deficits which could put downward pressure on bond prices (causing yields to increase). However, a long-term perspective on bond yields shows limited impact from crisis events with bond prices being driven by long-term trends.
So this is a good reminder that uncertainty is always present — it will be hard to predict what could happen in the future. However, reacting to events is not a useful thing to do when it comes to your investments.
It is likely that we will see many more conflicts and crises in the future, and unless you are reaching your goal soon, then it is better to stay the course. Ride out the short-term volatility and allow your well-constructed investment plan guide you through uncertain times. It can be challenging to invest during such periods but decades of evidence suggest it is the right thing to do.
If you would like to chat about this or your specific investments, come and speak to us.
