How Do Wars Impact The Stock Market?

There are three major wars being fought in the world today (Gaza/Lebanon, Ukraine, and Iran). The latter two are eerily similar. Both were unprovoked invasions of a weaker country by a stronger one. The invaders expected to destroy their opponents within weeks, forcing regime change. Instead, in both cases the weaker country demonstrated surprising military resilience and political ingenuity.

The outcome of these wars is still indeterminate. But in the meantime, as these conflicts continue, many of the world’s economies (including those of the invaders) are teetering in the wake of the fallout. What longer-term impact might these wars have on future stock market performance?

The following chart from Clearnomics shows how the S&P 500 performed one, five, and ten years after previous wars:

You can see that post-wartime market gains were generally quite positive, except after the Vietnam war and the Afghanistan/Iraq wars. Was there anything special about those conflicts that resulted in the poorer investment returns afterwards?

After Vietnam, one factor was the massive wartime spending – at least $110 billion ($650 billion in today’s dollars) by one Pentagon estimate. Increased government spending during wars is not unique to Vietnam. The outcome at that time was higher inflation, and the Fed’s attempt to raise rates in order to restrain it resulted in economic recessions in 1969 and 1973. But there were other impactful events occurring during that period as well. There was the termination of the Bretton Woods agreement pegging the U.S. dollar to gold, which resulted in a currency devaluation. There was also the oil shock resulting from several Middle East countries nationalizing their oil industries and quickly raising prices. All those events logically contributed to the anemic performance of the S&P 500 during those years.

Regarding Afghanistan and Iraq, those wars were believed to have cost more than double the cost of the Vietnam war. But because they began at a low point in that period’s economy cycle – right after an unrelated recession caused in part by the bursting of the Dot-Com Bubble in 2001 – there was enough unused capacity for production to increase without driving up prices and inflation. It’s likely the Dot-Com Bubble as well as the global financial crisis caused by the collapse of housing prices in 2008 had a bigger impact on the stock market than those wars did.

In summary, it’s difficult to extract any definitive pattern or correlation between wars and the capital markets. There are too many other factors involved. Which suggests that making investment decisions based on the progress or outcome of a war is probably not a good strategy. Current market prices always rapidly incorporate expectations about the effects of wars, pandemics, and pretty much any event impacting the performance of public companies. The most effective way to mitigate the market risk of any unexpected event, including war, is through broad diversification.

(Sources: Clearnomics, Investopedia, CQ Almanac, Center for Strategic & International Studies, History.com)