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How Different Asset Classes Perform During Periods of War and Geopolitical Uncertainty?

Humans are emotional creatures at their core and they often let their emotions influence their decisions, including the investment choices they make. It is, however, not a prudent idea to let logic take a backseat to emotions when it comes to investing your hard earned money.

As the specter of a nuclear conflict with Russia (America still does not have a missile defense shield; it could have one by now but we wasted trillions on a terrible health care law this century but this is another topic) or North Korea looms large, it would be a wise decision to have a strategic investment framework in place, in case the United States goes to war with either of those nations.

The ongoing Syrian crisis, in which both the US and Russia are involved, is becoming more volatile by the day. The US has 2,000 of its troops stationed in the country. It has pumped nearly $30 billion into its war campaign so far and is expected to spend another $13 billion this year. It wants to oust Assad but we don’t want this to turn into another Iraq where $1 trillion is spent without that much to show for it.

Trump was right when he said we should have obtained some oil from Iraq, how come we cannot get paid for our wonderful deeds (Saddam and his two sons were horrific)? But this is another topic.

Russia, on the other hand, wants to make sure Assad remains in power at all costs, as it is intent on protecting its naval facility in Tartus and retaining its influence in the region.

It also strongly believes that if the current crisis is to be solved through a peace and reconciliation process, Moscow should be the chief architect of it, not Washington. Syria has long been the most dependable ally of Russia in the Middle East and Putin firmly believes that Assad is the best bet to make sure it remains so.

Russia does not care if Assad uses WMD on his own people; Russia is amoral that way.

The situation in Syria could take a nasty turn at any moment, especially if there is another chemical weapons attack by the government. In such a scenario, it is vital for you to know what you should do with your money in case a war breaks out in the region.

Historical Stock Market Performance during War

The reaction of asset classes to a military conflict and their performance during and after the conflict usually depends on a couple of factors.

  • Whether it is a short or long war
  • Whether the epicenter of the conflict is the US or some other country

In the past four decades, every time the US launched a military operation on non-US soil, the reaction and performance of asset classes has been more or less the same. Initially, asset prices drop by around 4%, due to the fear that economic activities could be disrupted. The short-term drop in prices is usually followed by a rally in equities, which lasts anywhere from one to six months, during the course of which the prices increase by 7%.

War Does Not Adversely Impact Stocks for Long

As you can see from the table below, military conflicts usually do not have a negative impact on domestic stocks. In fact, the performance of stocks during wars has traditionally been better than their long-term averages. The performance of bonds during wars, on the contrary, has been worse than their long-term averages.

Stock market data from 1926 to 2013 shows that the performance of large-cap stocks and small-cap stocks has remained stable during wars, with the Vietnam War being the only exception, during the course of which stock returns were lesser than their historic averages. Still, the overall performance of stocks was better than that of bonds or cash.

What is interesting is that the stock market is less volatile during periods of military conflict compared to its performance during peacetime. Normally, you would expect that the feeling of uncertainty that results out of a military conflict would affect the stock market in a negative manner. Surprisingly, it has not been the case over the years, except during the Gulf War, when stock market volatility was comparable to its historical average.

There are a number of reasons why the performance of the capital market was different during the Gulf War compared to other wars. Firstly, the Gulf War lasted only for about six months, during which there was an increase in oil prices, which resulted in an economic recession in the US.

Previously, the US economy was exposed to natural resources and capital goods, both of which were in high demand during periods of war. In the 90’s, however, the economy underwent a transition, during which it shifted its focus away from heavy industry and transformed into a knowledge economy.

So, the demand for goods and resources during the Gulf War did not have any noticeable effect on the country’s economic growth and the performance of stock markets during the time period.

Underperformance of Bonds during War

The performance of bonds during war has always been worse than their historical average due to two reasons. First, inflation rate increases significantly during periods of war and the returns on bonds have traditionally never been high enough to fetch positive returns.

Secondly, governments tend to borrow more during wartime to finance their military operations, which results in an increase in bond yields and a decline in bond prices.

The performance of stock and bond markets usually depends on interest rates, inflation, economic growth, political climate, and a number of other factors. While a sudden decline is certainly possible in the event of a war between the US and North Korea, it is likely to be short-lived and not have any long-term impact on capital market returns.

Gold – Safe Haven in a War Economy

Gold has always been considered a safe haven for investors during turbulent times. The very possibility of a war has an impact on most other asset prices, which tilts the scale in favor of gold. Moreover, governments tend to print more money and spend more during wars, which is another reason why many people choose to invest in precious metals like gold.

In the past four decades, gold prices have always soared in the event of a military conflict or major geopolitical crisis – be it the Iranian Revolution, Iran-Iraq war, the Soviet Union’s invasion of Afghanistan, or the Gulf War. Even after the 9/11 attacks, gold prices increased significantly. In 2014, the very possibility of a US intervention in Syria resulted in an increase in gold prices again.

If you want to see one way how gold is found and taken out of the ground watch the stellar Discovery Channel show Gold Rush but this is another topic.

Should You Hoard Cash during War?

According to Barton Biggs, an investment manager who is known for predicting the dot com bubble, hoarding cash during wartime is never a salient idea. He explains the rationale behind this investment advice in his book ‘Wealth, War, and Wisdom’.

Biggs says that even if your country emerges victorious from the war, the value of your cash holdings could take a hit due to inflation. Moreover, during periods of war, the internal security of a country is usually vulnerable, which results in an increase in crime rate as people are less likely to follow the law. Hoarding cash in such a scenario means you could be a potential target for thieves, robbers, and other such antisocial elements.

This is another reason why it is important to have guns in your home because what happens when government breaks down? The movie Contagion showed this glaring scenario very well. If things fall apart, your cash will mean nothing. Weapons, canned food, gold, tools, will all be much more critical than cash – they will be the new currency.

Which way will Cryptocurrency Go in Times of Geopolitical Turbulence?

While it seems counterintuitive, the volatile nature of cryptocurrencies as an asset class may work in their favor in times of geopolitical turbulence. Uncertain times bring along the risk of currency non-convertibility, capital controls, and asset freeze. The veteran crypto investors, who have the ability to swim against the current, may only get more encouraged to reject traditional currency systems and back cryptocurrencies in times of heightened risk.

Just as gold earned a reputation as a ‘safe haven’ during periods of global upheaval, digital assets could possibly provide a similar reprieve to investors. Portfolio diversification is a way to combat risk in uncertain times, and cryptocurrency offers a clear diversification pathway to many.

Choosing the Right Equities in Times of Conflict

Market corrections are an inevitable aftereffect of any major military conflict. If you are a prudent investor, you should not only know how to make money on the upside, but also know how to limit your losses on the downside.

Historically, defensive sectors such as telecom, utilities, healthcare, and consumer staples tend to hold up better than cyclical sectors. Large caps tend to perform better than small caps, which are considered a high-risk option by many. Similarly, American equities have always outperformed their international counterparts, if the conflict is influenced by global factors rather than domestic ones.

Get all of our top stock and crypto picks, whether in times of war or peace.

By |2018-04-23T11:02:03+00:00April 23rd, 2018|Gold & Silver Commentary|

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Contributing author to Gold Stock Bull