Welcome to Finance and Fury. This episode is a little outside of the box, the topic comes from a listener, Mario.

He asked the question of how does someone both manage and protect their wealth in times of war? and are there actual strategies that one can implement if a war was to break out?

So, in this episode we will look at if there are strategies that are implemented as part of managing a portfolio to safeguard against the impacts war has on share markets and other asset classes.


Before we get into that – there are some things to consider when looking at this topic –

  1. Wars are not all built the same – you can have civil war, boarder conflicts, or even major conflicts like a world war – since WW2 there has also been the potential for a full-scale nuclear war – leasing to a mad max/fallout post-apocalyptic world scenario
    1. There are always wars going on – 3 wars saw 10k more combat related deaths last year, 14 with 1k to 10k, 33 other conflicts
    2. The major consideration out of all of these – is your country affected? Countries ravaged by war suffer severe losses – in terms of life, disruption of resources, occupations
  2. Times have changed – Switzerland used to be considered an independent country – but now the world is interconnected in a way that would seem foreign to those living in through the times of WW1 and 2
  3. Wealth has changed – used to be mostly physical – and financial contracts have changed
    1. Back in WW1 or wars before – Those who offloaded wealth – nazis with physical wealth – to avoid it being confiscated – would do so in a physical manner
    2. Gold, artwork – this would be transferred to neutral countries like Switzerland

Whilst wars are awful – one piece of good news is that you probably don’t need to worry about most investments if a war breaks out – especially long term

  1. This is assuming that it is a similar style of war that we have seen – if it is a major form of conflict – say the US and the West versus China and Russia – in a nuclear fallout situation – the best investment would be in your own survival – making sure you have your own food, water and power sources –
  2. But the good news – if there can be any when wars are declared – is that most financial markets tend to not be negatively affected in the long term
  3. Markets don’t deal well with uncertainty well – if a major conflict were to erupt with major uncertainty, then the share markets may drop – but markets have seen many conflicts
  4. The major wars that affect financial markets have been financial wars – been raging since 2009/10 – with currency wars – but lets say a hot war breaks out – what are the safest asset classes to be in and how should you manage your funds

Asset classes to look at –

  1. Defensive assets such as bonds are not that safe in times of war – this is because Bonds generally underperformed during times of war – this is for two reasons
    1. war tends to be inflationary – you see massive supply shocks, increasing prices – bonds do not like inflation
      1. most bonds pay a fixed income and have a nominal face value to be paid back at maturity – hence their value dwindle when inflation rises – so inflation will traditionally drive the price of the bond lower to compensate for this factor
    2. governments tend to borrow more during wartime – creating more supply of debt which again tends to drive prices down
      1. Historically this has been an issue – but with CBs and QE – this isn’t as much of a concern, as long as QE were to increase to soak up any surplus supply – which would depend on the country
    3. How well the debt markets go really does depends on who is the likely victor of a war is –
      1. Bonds are debt issued by either governments or companies – if a war was to break out and a nations government gets overrun and its domestic companies get destroyed in their output – both see their ability to honour their debts being diminished – making the asset worthless – markets would respond poorly to this – so the price of the bonds would become almost worthless
      2. US bonds have historically been the favoured destination for investors since WWII – considered a global superpower – if a war breaks out tomorrow – the US will be the likely winner – not talking about their failed ‘nation building’ wars – like in Iraq and Afghanistan – there is really no winning those wars
      3. Looking at the losers of the war – Germany, Japan, Italy – fixed income had severely negative returns – German bill investors lost everything in 1923
        1. Going back further – German bonds investors lost over 92% in real terms after World War I. Admittedly inflation was virulent in a war-torn world, and fixed income is not the place to be in such an environment. In the chaotic, disorderly environment of the war years in the Loser nations, you can’t sell bonds or cash in bills any more that you can trade stocks.
      4. So in most cases – if wars break out there is little upsides to bond markets – they can fail at their defensive purpose, and also provide lower returns

Shares – these actually can perform rather well through longer periods of wars

  1. a review of market reactions during the major wars between 1926 and 2013 shows that the impact of war on US stocks were largely positive –
    1. WWII, the Korean War, Vietnam and the first Gulf War were all periods in which “both large-cap and small-cap stocks outperformed” their long-run averages
    2. more surprisingly still, volatility did not take off – indeed, markets experienced lower volatility than normal – in a sad way, markets may have become accustomed to war
  2. Share markets have largely shrugged off past geopolitical conflicts – they can initially see some volatility or losses – but recover rather quickly – Why would this be the case?
    1. As serious as wars get – you need to ask yourself how likely any wars are to have to have a material impact on the major economies of the world – with this flowing into affecting the fundamentals of corporate profits of the companies listed on the markets – most major markets have been affected by wars due to this reason – the companies are untouched by modern day conflicts
    2. Plus the U.S. has spent an estimated $6.4 trillion on wars post 9/11 – it appears willing to keep spending if things escalate – this is money flowing into companies that run the war machine – so it helps to boost markets
    3. Looking at history – From the start of WWII until it ended in late 1945 – the US market was up a total of 50% – more than 7% per year over the 6 year timeframe
      1. When including WW1 from 1914 to 1918, just under 4 years – U.S. stock market was up a combined 115% over this 10 year period
      2. Beyond the tragic loss of life – the US economy was largely unaffected – it saw a ramping up with many companies and resources being reassigned to the war machine
    4. It is in periods of major uncertainty where the share market suffers the most
      1. when there is a pre-war phase – i.e. there is an increase in the likelihood of war breaking out – this tends to decrease share prices – but the ultimate outbreak of a war increases them – interestingly – markets can predict, or determine the outcome of wars – as some examples
        1. Japan’s market peaked in 1942 – as up until this point they were winning on all major fronts – technically controlled the largest geographical span of control of battles in human history – most of this was across water – but it was an immense theatre of war
        2. the US market turned around after the Battle of Midway in late May of 1943 – first major win by the US after getting beaten time and again by the initially superior Japanese fleet
  • that the British stock market bottomed at the time of the Battle of Britain in 1940 – major air conflict between the RAF ad the Luftwaffe – which the RAF ended up winning
  1. the German market reached its high-water mark in December 1941 – about 6 months after operation Barbarossa began (the German offensive on Russia) as it became clear that the casualties and likelihood of compete victory was in doubt
  1. But in cases when a war starts as a surprise – the outbreak of a war decreases share prices due to the initial uncertainty shocks
    1. this phenomenon can be called “the war puzzle” – but there is no clear one explanation why share increase significantly once war breaks out after a prelude –
    2. As an example – Iraq war – in the lead up to this war after 9/11 – The ASX fell by around 22% – but then investors were encouraged by the start of military action when it finally happened in 2003 – because it removed the uncertainty that had plagued markets up until then
  2. In essence how long a war goes for, what sort of damage is done, and what is priced in before it happens all play a role before investors refocus on the main drivers of financial markets – the economy and earnings.
    1. Over the past 100 years – markets have been conditioned not to overreact to political and geopolitical shocks for two reasons
      1. There is the belief that there would be no significant subsequent intensification of the initial shock beyond what has already been priced in
      2. central banks stood ready and able to repress financial volatility – i.e. print the way out of trouble
    2. Investors should technically be buying the dips

Gold – one safe haven that does do well in times of war is gold

  1. Gold has been a good hedge against geopolitical upheaval and uncertainty
  2. Looking at the history of Europe during World War II indicates gold and jewellery work fairly well to protect a small amount of a wealth – because back then this was purely what you could carry on your person – but there were risks to this – conquerors demand the physical assets – and your bank will give it to them – back then people would try to take their wealth with them – but now things are different – as you can have paper gold in the form of ETFs –  
  3. If you have physical gold this is probably better – as long as it is stored in a secure location on your own property and assuming that an occupying force isn’t knocking down your door
  4. But when times are uncertain – gold can go well as a hedge to the initial shocks the share market can suffer from the build up to wars

Summary – But what are the takeaway lessons?

  1. For protecting wealth and getting positive returns in times of wars – the share market has been a better bet than bonds
    1. Gold can also provide a good hedge – also, I would guess that some crypto markets would do well also – hard for one single nation to confiscate a global market
    2. Over the long run, equities are the place to be — even in countries that are losing a war, because historically, even they have managed to beat inflation
  2. However – even in the countries on the winning side – money invested in equities should be diversified – no company has ever had a sustainable, forever competitive advantage
  3. The historical records indicates that equities over the long run in relation to war are highly likely to earn a return well in excess of the inflation rates as well as provide a positive return during the period a war is occurring
    1. Share in a stable country have a higher degree of certainty and can achieve a long-term better real return over the countries that may be the losers of any wars
  4. It is always good to diversify – if you are really worried about a war coming to Australia’s shores – shares can work better than bonds – if you are worried about a nuclear winter – then any financial investment is likely to do you little good – better to start building a bunker and buying some MRE

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/ 

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