The Compound and Friends - What happens to the stock market during a time of war? (with Josh and Ben)

Starting point is 00:00:00 It's the question on everyone's mind this week. What will happen to my portfolio if a war breaks out? Recent news out of the Middle East. Obviously, no one is very excited about what we're seeing and hearing. I have Ben Carlson with me. Ben is the head of institutional asset management at Ritholtz Wealth Management, sits on our investment committee. He wrote a fantastic piece at Fortune about surprising stock market returns during wartime.

Starting point is 00:00:26 We're going to get into it with Ben in just a moment. Stick around. Okay. First of all, greetings from New York, Ben. How are you? Everything's good here in Michigan. All right. I loved your article. I thought you struck the right balance between, okay, yeah, it's not great. We're not rooting for a war. However, stocks have actually done better than most people would expect during some of the most violent and long-ranging conflicts that America has ever seen. That's pretty much what you found in the data, right? The stock market just hates uncertainty. And there's nothing more uncertain than time of war.

Starting point is 00:01:04 But I went back and looked all the way back to World War I and World War II, the Korean War, The stock market just hates uncertainty. And there's nothing more uncertain than time of war. But I went back and looked all the way back to World War I and World War II, the Korean War, Vietnam. And World War I initially saw the Dow fall like 30% six months after the war started in 1914. But then the stock market closed for six months, which is the longest that's ever happened before. And it's never happened since. No, I can't imagine that happening today, the stock market just closing. Because basically liquidity dried up and everyone went away to war, obviously, and business sort of stopped. But the year after that, 1915, stocks were up almost 90%, which is still the biggest year in the Dow on record.

Starting point is 00:01:36 Right. 88% return after the market reopened, which means there was a lot of pent-up demand to buy U.S. stocks. Surprisingly, yeah. And from the time the war started in 1914 through 1918, the Dow was up almost 44%, and that's like 9% annually. Same thing happened in World War II when it started in 1939 when Hitler invaded Poland. The Dow was up through 1945 when it ended more than 50%. So if you take the time from we were in World War I and we were in World War II, stocks were up over 100% in those two periods. So that's roughly nine years combined of just absolute war. Which is crazy. And it was surprising, especially in World War II,

Starting point is 00:02:19 we had this huge rise in business. And and actually the year after the war was over that we had like 18% inflation in 1946 because business just took off, surprising basically everyone who assumed that things would come to a screeching halt. Yeah, so one thing I wanted to add to that, when we went to war in World War I and World War II, like the whole country literally had its lives changed in order to facilitate these wars. Like people changed jobs to help build munitions. And like many, many families had multiple members that were away in different theaters in World War II especially. So it's like very different than recent wartime America. Yeah, and that's the big difference is that it was just a collective thing and so many more people were involved. Whereas today, obviously, there's plenty of servicemen and women, but we wouldn't have as many people go over as we did and as many

Starting point is 00:03:14 people. So that's obviously a difference. But I just was surprised, even in Korea and Vietnam, stocks were up. And it was actually after the war periods where we had these kind of economic hiccups. So Vietnam, that ceasefire was in 1973, which was right when that huge bear market and nasty economy, economic collapse happened in 73, 74. And the same thing, there was a minor recession following World War II. But I was just shocked to find that stocks actually did really well during all of these periods by and large, which is hard to imagine. So you have the Korean War, 1950 to 1953. It's relatively brief. It's sort of at the beginning of the Cold War. But the fighting itself is only a couple of years. You have the market up 60%, the Dow Jones. Yeah. And even during something like a smaller period, like the Cuban Missile

Starting point is 00:04:03 Crisis, which I think was 13 days, the Dow was down 1% when we were on the brink of nuclear war. And so I think just thinking back to those periods, the last thing people at those times were thinking about was the stock market. There was obviously way more going on. But it's kind of hard to wrap your head around that as an investor today. You would assume, well, people were fearful. The world was potentially coming to an end in these situations. People must have been selling stocks. And actually, the world went on and things did just fine in the market, which is kind of surprising. Well, there's two things, though, that I think are worth bringing up, which I know you just wrote an article. You didn't do a book on this. But the first thing is

Starting point is 00:04:40 that you get a lot of inflation when we go into war historically because you got to build a whole lot of equipment and that inflation ends up benefiting the stock market in the form of government contracts, higher revenues, prices go up. So you see the stock market rise because the government starts running a huge deficit is the first thing. And then the second thing, I feel like when we talk about uncertainty, a lot of times the uncertain period is the run-up to the war. And then when we finally mobilize, not that it's not uncertain for the people who've got family that are going off to fight, but in the investor mindset, it's like, okay, it's a war. Now we know officially there's no more will we or won't we enter Europe or will we or won't we strike back

Starting point is 00:05:32 at Japan? So I think that plays a role in it too. It's almost like an exhale when you know, okay, it's a war. And my whole point was, I could give you the headlines for the next three years if this is something that continues. Maybe it'll go away and who knows. But if I could give you the headlines for the next three years if this is something that continues. Maybe it'll go away, and who knows? But if I could give you the headlines, you still might not know how it's going to play out for the markets, because no one knows what the reaction is going to be. And to your point, that uncertainty, sometimes just starting it, makes the market feel like there's some certainty involved there. Even after the 9-11 attack, where I think stocks fell 15%, they gave back all the gains. They got back all the gains within a couple of months.

Starting point is 00:06:08 And so even a period like that that sort of comes out of nowhere and you don't have this buildup, you might have this initial fall and then things come back. So my whole point is just people need to slow their roll a little bit with overreacting to what this could mean for the markets when we really just have no clue what the reaction is going to be. And sometimes it's counterintuitive. So not to put words into your mouth, but I think the other thing that you're saying, you're not saying war is bullish for stocks. You're saying that, you know, a lot of times how the market acts in wartime has to do with other factors, like a recession that we may or may not be in the middle of concurrent with a conflict. And a really good example of that is we invade Iraq in 03. We think it's going to be like a sequel to the first one

Starting point is 00:06:54 and it's going to be quick. And it turns out the invasion is quick, but then we're occupying for 17 years or whatever. And that period kind of coincides with the real estate crisis. If you were looking at the invasion of Iraq in 03 and you wanted to say how did stocks do over the next 10 years, it would be very misleading

Starting point is 00:07:13 because a lot of the damage in the stock market had absolutely nothing to do with Iraq. It wasn't a great thing but it wasn't really involved. What I found is the year we went into war, which was the spring of 2003, stocks were up like 30% from that point on over the remainder of the year and for a few years after that. But again, that was coming out of the bear market. They were coming out of the dot-com crash. Right.

Starting point is 00:07:35 They were coming out of the 2000 to 2002 crash. So, right. How much credit do you want to give the war? Not that much. No, yeah. The context of where we are, and maybe that's the point for some people people is they're worried markets are high. They've been rising for 10 years. Maybe this is the tipping point that makes some people want to sell, which I guess that's an argument you could talk yourself into. But that's the point is that it's just very context dependent.

Starting point is 00:07:56 Well, so, you know, we've got advisors talking to clients about this issue. And, you know, I think people are nervous, not because of just money, but because Iran is working on a nuclear program, and it's got proxy armies all over the region and elsewhere in the world. And I think people are worried for more reasons than just their retirement. But yeah, we're going to field questions about, you know, what should we do if we think we're about to be at war or it's likely that war could break out in the Middle East and we might have to play a part in it or whatever, there really isn't an answer like, oh, war breaks out on day one, on day 30, this is what you could expect from treasuries or from stocks. There are just too many factors to condense it into an easy answer for an investor.

Starting point is 00:08:47 Except we know Bitcoin will rise. We do know that one externality. All right. Well, listen, everyone should read Ben's new article at Fortune. We're going to post a link to it below. I thought it was just a really easy to understand summation of how the Dow Jones has done during various major conflicts. And of course, let's hope we don't have a major conflict anytime soon.

Starting point is 00:09:09 Once again, we appreciate all your feedback here. Make sure you leave us your comments. What are your thoughts on this topic? We always love to hear that. Go ahead and subscribe if you haven't already. And Ben and I will see you very soon.

The Compound and Friends - What happens to the stock market during a time of war? (with Josh and Ben)

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