War and Markets
Given the increasingly tense global political climate, I've been curious about what life will look like in the event of a global hot war. What happens to daily life? What happens to work? What happens to assets that we painstakingly accumulated?
As someone who started her career a year before the Global Financial Crisis of 2008/9, and in particular working on financial institutions M&A (I can hear some of you laughing), market crashes have lurked at the back of my mind since.
War happens to dovetail with market crashes. At first I assumed that war creates market crashes because fear and panic would obviously cause the market to tank. On second thought, I thought perhaps the opposite cause-effect relationship could also be true: a market crash results in economic conditions that lead to war (e.g. the Great Depression in the 1930s, followed by World War II).
While trying to figure out what history tells us about war and markets, I came across a book called A History of the United States in Five Crashes by Scott Nations. There were surprising lessons that I wanted to share.
As we stare into the mouths of predators ready to go to war, I hope this contributes to your own financial defense.
The Five Crashes
2010: The Flash Crash
Economic conditions in Greece led a runaway computer algorithm to create an avalanche of bad trades, causing the Dow to shed 1 trillion dollars in minutes.
2008: The Great Recession (aka The Global Financial Crisis)
Profligate mortgage practices ultimately brought the world’s largest banks to their knees, along with the economy and employment.
1987: Black Monday
A complex financial product called portfolio insurance, combined with corporate raiders (private equity), led the Dow to drop 23% in one day.
1929: Black Tuesday
A feckless Fed and a newfangled financial product called investment trusts together led the bubble to burst, leading to the 10-year Great Depression, the longest, deepest and most widespread depression of the 20th century.
1907: The Panic of 1907
One of the largest banks attempted to manipulate the stock market, instead causing the Dow to lose half its value. JP Morgan intervened to save the day.
(Side note: The book was published in 2017, so it misses our post-COVID market rout. I hold out hope for an updated edition. I hope the author will also add a chapter on the dot-com crash in 2000/2001, which would be highly relevant today given how far the market has skewed towards tech stocks. Selfishly, I hope he adds a chapter on the 1997 Asian Financial Crisis, which toppled governments and bankrupted companies, governments, and individuals; it also affected my family significantly.)
I’m not going to summarize the crashes (here is an actual book summary), but I wanted to surface a few factors that make repeat appearances in a market crash.
The market appreciates aggressively, seemingly with no limits to reason
New financial contraptions appear that we think we understand better than we do. These tend to promise more return for less risk - a free lunch, basically
The government makes bad decisions on monetary policy or regulatory action. While well-motivated, such as to rein in monopolies, they make the right moves at the wrong time
An external catalyst, such as war or a natural disaster, often pushes everything past the tipping point
We can immediately draw parallels between our world today and the factors above.
First, from about 2010 to 2021, we had a 10-year bull run almost unprecedented in history. And it shocked most people that despite a global pandemic, markets were frothier than anyone could have expected.
Second, while I can’t think of any one specific financial contraption, the speculative DeFi/crypto markets could certainly count. Cryptocurrencies were not originally made to be a tool for speculation or fraud, but unfortunately it has turned this way. The “free lunch” that centralized exchanges were offering in high-yield accounts turned out to be very expensive for those that lost their capital.
Third, governments around the world have printed too much money for too long. Now they are trying and mostly failing to fight the inflation monster. The US debt ceiling discussion continues to be a major wild card. What will happen? Time will tell.
Fourth, war came to Ukraine in 2022, while geopolitical relations continue to deteriorate due to economic tension, cybersecurity infractions and matters of sovereignty (Taiwan, South China Sea). (And don’t forget the ongoing debate about where COVID came from.) In addition to this, climate change continues to displace people and drive pests and animals beyond their usual borders.
What do we make of this? We are already in a market crash. Parts of the world are in technical recession, while the rest are almost in recession. What’s the point of this discussion?
My concern is that the third and fourth factors (government action and war/natural disaster) haven’t fully played out yet. In addition, economists are still wary of a protracted recession into 2024.
I think our portfolios can still take a bigger, extended beating.
What does this mean for me, if one were worried about war from a market perspective?
First, to stay invested in the stock market because… War is good for the economy and the stock market!
The threat of war initially causes markets to fall, and sometimes the market may even be suspended (though typically not for long). Over time, they recover as uncertainty pulls back and people settle into the new reality.
The new reality is that large, stable budgets from the government and military lead to strong GDP growth, which feeds back into the stock market. This was so counterintuitive to me that I had to re-read parts of the book several times.
However, after the war, fortunes diverge. If you are on the winning side, the sun continues to shine on your portfolio. But if you were on the losing side, your assets are likely to be worth a fraction of what they used to, and may even be zeroed out - which is another reason to diversify.
Second, to aggressively diversify across industries and exposures that can either stay resilient in times of crisis, or can reap the rewards of a market that stays more buoyant expected
Diversification is not a habit I have developed the discipline for. But even if it means missing out on a home run, I want to sleep better knowing that in most scenarios I will not be forced to make dramatic and undesirable choices.
Third, to get defensive with spending and asset allocation
I’d love to have spare capital to invest if and when things do go belly up.
I didn’t have time for a more detailed piece, but I hope you find value in this nonetheless. Comments and discussions welcome.
Further reading
A History of the United States in Five Crashes by Scott Nations (Kindle book. Alternatively, here is someone’s summary)
Wealth, War and Wisdom by Barton Biggs (Kindle)
https://seekingalpha.com/article/4488660-how-stock-market-reacts-war-based-crash