With the Russia-Ukraine war continuing to rattle global equity markets, we revisit historical analogs of how markets typically behave around wars.
Variant Perception, March 5, 2022
With the Russia-Ukraine war continuing to rattle global equity markets, we revisit historical analogs of how markets typically behave around wars. The following is an excerpt from our Feb 2020 report, Recessions and Shocks.
We find that markets tend not to front-run the evolution of an exogenous event the same way they do with business cycles. Markets, historically, have often waited for a tangible improvement to the underlying event that caused their sell-off before they reach a tradeable bottom.
At the start of WWI, the catalyst for the market sell-off was the declaration of war on Serbia by the Austro-Hungarian Empire in July 1914. The market sold-off about 10%, then the market was closed for almost 6 months. When the market re-opened, it slumped 25%, but then rallied through the rest of the war. The market’s re-opening was itself a positive development in the exogenous event, despite the war carrying on for another three years.
In WWII the pivotal event for the US was Japan’s surprise attack on Pearl Harbor in 1941 that dragged the US fully into the Pacific theatre and preceded a large market sell-off. However, it wasn’t until the Battle of Coral Sea in May 1942 which showed the tide of war was turning that the market bottomed. It was still an overall victory for the Japanese, but it was the first time the US had curtailed a Japanese advance. The market ended up rallying through until 1946.
In the Korean War in 1950, the trigger for the sell-off was the sudden incursion of North Korea into South Korean territory. In this case, ‘good’ news from the market’s perspective arrived pretty quickly as South Korean troops managed to hold off the North Korea troops effectively. Even though fighting continued until 1953, this was enough for the market to rally for most of the next three years. Such a sudden recovery may in part be due to recency bias: World War II had recently been won by the Allies and this was a smaller challenge by comparison.
Fast forward to 1990 and the First Gulf War. A surprise invasion by Iraqi troops into Kuwait put the West’s oil security at risk and the market started to sell off. It wasn’t until operation Desert Storm was launched in January 1991 that markets began to recover and rallied sharply.
Two of the most recent exogenous shocks excluding the current one are the Second Gulf War and the 9/11 terrorist attacks. The 9/11 attacks in 2001 caused the market to sell off about 12% (over a period including when markets were closed for a week), but they had made back their losses by November. There was no clear trigger for an improvement in the underlying event, other than a patriotic call for consumers to get out and start spending again, which they duly did.
The market sold off little after the announcement of the US invasion or Iraq in March 2003. This was partly as it was “priced in” - there had been ongoing discussions between the US and its allies about creating a “coalition of the willing” in the run up to the war. And partly as the market was only just emerging from the 2000-2002 bear market. Bear markets already carry a lot of bad news so it takes a real negative shock to have a notable and lasting impact.