Key Points:
- The performance of stocks, sectors, and factors during times of war can be surprising and counterintuitive.
- Historical analysis shows that the US stock market expanded during the US Civil War and World War II, with only a net decline during World War I.
- The long-short performance of size, value, and momentum factors during World War II was positive, offering potential diversification benefits. However, these results need to be evaluated considering transaction costs and the inefficiency of shorting stocks at the time.
- In terms of sector performance during World War II, industries like printing and publishing, alcoholic drinks, and personal services emerged as the top performers, while tobacco companies performed poorly despite positive returns.
- Bonds, short-term and long-term Treasuries, as well as corporate bonds, all yielded positive returns during World War II, with corporate bonds having positive real returns after inflation.
- While historical analysis can provide insights, it is difficult to predict the performance of stocks and other assets in future wars, especially in the face of potential catastrophic events such as nuclear conflict.
Introduction
Before 2020, the threat of a global pandemic shutting down the world economy was not a top-of-mind concern for most investors. However, the COVID-19 pandemic brought unprecedented economic disruption and changed the investment landscape. Similarly, before 2022, a third world war seemed highly unlikely. However, the Russian invasion of Ukraine has increased the odds, leading to questions about the performance of stocks, sectors, and factors during times of war.
Past experiences, such as the impact of major wars like the US Civil War, World War I, and World War II on the US stock market, can provide valuable insights into how various assets have performed in times of conflict.
Stock Performance in Major Wars
Examining the US stock market’s performance during major wars, including the US Civil War, World War I, and World War II, reveals some interesting trends. Despite the significant human and economic toll of these wars, the US stock market expanded during the US Civil War and World War II. Only in World War I did it experience a net decline.
Factor Performance in Wartime
Analyzing factor performance during World War II provides intriguing insights. The long-short performance of the size, value, and momentum factors was positive but needs to be evaluated considering transaction costs and the inefficiency of shorting stocks at that time. The value factor generated a compound annual growth rate (CAGR) of 16%, while the size factor achieved 11%.
Performance of Industries during Wartime
Examining sector performance during World War II reveals unexpected outcomes. The top-performing sector was printing and publishing, followed by alcoholic drinks and personal services. Meanwhile, tobacco companies performed poorly, despite positive returns, creating a paradox when compared to the beer and liquor sector’s significant gains. Steel, chemical, and aircraft companies also did not fare as well as expected during the war.
Asset Class Performance in Wartime
Comparing the performance of bonds and stocks during World War II, equities generated the highest nominal returns. However, short-term and long-term Treasuries, as well as corporate bonds, also yielded positive returns. In terms of real returns after inflation, only corporate bonds remained positive. It is important to note that the bonds sold by Axis powers became worthless when they lost the war.
Further Thoughts
While historical analysis provides insights into past performance, it is challenging to predict future performance during wars, especially considering the potential use of nuclear weapons. In such catastrophic scenarios, investment options may be limited, and capital preservation would likely take precedence over capital growth. Active management in such uncertain times becomes even more difficult.
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