Why markets fluctuate around wars
Investor anxiety tends to peak as tensions simmer and countries inch closer to war. Markets have experienced sudden sell-offs in response to surprise events that drew the U.S. into conflict, such as the bombing of Pearl Harbor and the invasion of South Korea. In those cases, investors had less time to price in the risk of conflict and reallocate their capital accordingly. Once a war becomes more certain, investors can view it as a risk, which can be modeled and therefore priced, according to research on market performance during wartime by the Swiss Finance Institute.
As the contours of a war become clearer, investors can predict and react to which sectors – such as defense and aerospace – may benefit from wartime government spending or new resource demands, the Swiss Finance Institute found.
Conflicts aren’t the only events that drive markets. The broader macroeconomic environment during wartime matters as well, which is highlighted by an analysis of market performance during wars by Invesco. For example, the 2008 recession drove markets downward during the Wars in Afghanistan and Iraq but had no connection to those conflicts.
In short, the Swiss Finance Institute found that markets tend to fall in the lead-up to war and immediately after surprise conflicts but often rally once war begins. The reason: The uncertainty before war creates more perceived risk than the war itself. Even messy or prolonged wars can bring enough clarity to ease investor anxiety and stabilize markets.
What investors should remember during wartime
Markets don’t fear war; they fear uncertainty. Across a century of U.S. conflicts, stocks often dipped before fighting began then rallied once the outcome looked clearer.
The historical data on stock market performance during U.S. conflicts shows:
- Stock markets often dip in the lead-up to wars but rise after they begin.
- Small-cap stocks tend to outperform during conflict.
- Surprise wars trigger sharper declines than anticipated ones.
Wars are wrought with unpredictability and chaos, especially in early days, which the market can reflect in its performance. But investors are encouraged to stay the course and take a longer view. In peace and wartime, history favors those who hold.
