Investing During Wars
It is an undeniable fact that wars, political scandals, natural disasters and now even a pandemic has become an integral part of our lives and economies. As of today, we are not only dealing with COVID-19, we are also amidst an ongoing geopolitical standoff with China at the border. People deal with it in different ways, though some prefer not to think about it, an opportunist on the other hand would try to make the best out of the pessimistic scenario and mint a few bucks. But how to do so is the question under consideration. To understand that, we first need to enhance our knowledge of how these standoffs effect the economies and the market.
Before getting on to what war and its impact are on the economy and markets, we need to understand what actually happens in a war:
When two countries are at war with each other, attention of the government and the public is diverted towards the war effort. Governments have a defense budget, but these are mainly to keep the men and machinery fighting fit. But when it is at war,these arsenal and machines are consumed and need to be replenished fast.
Due to this, defense expenditure now becomes an expense with a meter running fast and as a result economic activity in the defense sector picks up.
Resources meant for other sectors get utilized by the government and in order to meet the fund requirement, the government either approaches markets or fulfills the need by printing money, thereby inducing inflation.
These testing times add apprehension in the minds of an investor, especially the retail ones who feel that the situation could escalate anytime and lead to a larger engagement. Their rationale for the fear is that a long and prolonged engagement with the enemy is bad for the economy. This makes logical sense as the government will be forced to divert the limited resource to the defense forces rather than using it for asset creation.
But, as we all know, market is supreme to all opinions, it behaves the way it does and not how we perceive it to. On that note, let us dive deep and take a look at a few historical instances of geo-political skirmishes and war to know how market behaves in situations like these.
Impact of these situations on market differ a lot based on where they occurred since it is not possible to cover all standoffs that occurred throughout the history of financial markets across the world and to come up with a correlation we would stick to the Indian and the US markets for our discussion.
US markets during war:
As it can be evidently seen in the above image, stock markets have done quite well (for the most part) during past wars. So-called safe-haven fixed income investments, on the other hand, have not provided quite the protection that investors expect during times of uncertainty. Common financial sense dictates that capital markets do not like uncertainty—which wars bring in abundance.
It is not the case that stock markets don’t fall down in times like these, they do, but the catch is that the fall is short lived and the recovery is quick with almost no hindrance or bull traps(a situation where markets rise after a crash once it bottoms out, only to fall again and make new lows).
The image above, consisting the list of the other standoffs where markets fell including the 9/11 attacks at WTC, New York suggests the same showing data of how much time it took markets to recoup after the fall.
Indian markets during war:
As far as Indian markets are concerned, since the time NSE index has been constructed – in the 1990s the country has not seen a full blown war. The closest it has come to a war was on the Kargil issue. The first report of intrusion by Pakistan was reported on May 3, 1999. Indian army backed by the government launched an aggressive retaliation to evacuate Pakistani army. By July 14, 1999 Indian army had officially reclaimed all land prompting the then Prime Minister Atal Bihari Vajpayee to officially declare that the operation was successful.
On May 3, 1999 NSE NIFTY closed the day at 980 levels. Market on this day had no idea about the intrusion. But by July 14, 1999 it closed at 1340 levels a gain of 37 per cent, which also was the year’s high level. There was barely any noticeable correction during this period.
While a single event is too small to extrapolate future events, The surgical strike by Indian military on Pakistan soil took everyone by surprise. The news was announced while the market was open. As the Indian Army personnel announced the details of the surgical strike, investors panicked and started selling in the market. Indian markets closed nearly 1.6 per cent lower, but on an intra-day basis lost nearly 3 per cent from their highs on the announcement. However, markets rebounded since then and and gave close above the levels where they were before the strike, in not more than a week.
What’s behind this strong performance?
There are several potential arguments for the strong performance of stock markets in wartime:
Wars bring the nation together, and this patriotic spirit may come in the form of investment in domestic companies.
A more compelling argument, perhaps, is that wars magnify government spending, which results in increased revenue and earnings for those companies that are awarded government contracts. With increased spending and the induced inflation, the GDP rises which somehow is perceived and taken positively by the investors.
Wars also entail spending on rebuilding. From a fixed income standpoint, government spending leads to spiking inflation, resulting in rising interest rates and falling bond prices.
How to deal with standoffs in future?
Historical data suggests that these falls are mostly before the war breaks out i.e during the period of escalation and even for the fall which comes out after the war breaks out, it recovers quickly more often than not.
Now to conclude w.r.t ‘how to go about investing’ in these times, based on what history has to say, one should stick to the basics i.e
Don’t panic, there is no reason to change your long-term asset allocation.
Consider over weighting historically defensive stocks and asset classes as a short-term solution.
Take an SIP approach as the fall would be a good opportunity to average out and get your stocks at a cheaper valuation, in times when the fall is a little prolonged.
One should look at red flags to time the market , such as rising bond yields which show upward movement during the period of escalation when government reaches deep for raising capital as it believes that the country is going to enter in a full fledged war.