The fog of war is even thicker for investors than it is for army generals, according to
The First World War came as a shock to investors as up until the week before the outbreak, prices in the bond, currency and money markets had changed little. Then all hell broke loose, according to Niall Ferguson, a historian, in a paper published in 2008. “The City saw in a flash the significance of the war,” wrote a newspaper on August 1, 1914.
< p>Whether financial markets could once again underestimate the risk of a global conflict is a key question analyzed by the Economist.
Under the nightmare scenario, the path to a Third World War started two years ago when Russian troops gathered on the Ukrainian border.
Today Israel's battle against Hamas and the Palestinians as a whole has the nightmarish potential to spread beyond the borders of the two sides. US military support is vital to both Ukraine and Israel, while in Iraq and Syria the superpower's bases have come under fire, possibly from armed groups backed by Iran.
If the China decides it's time to take advantage of a distracted superpower and invade Taiwan, America could very easily end up being dragged into three wars at once. The rest of the world is at risk of these wars interacting and turning into something even more destructive.
Markets are “unsettled” in the face of risk
This scenario would naturally place economic damage far down the list of horrors. Even so, it's part of an investor's job to consider exactly what it would mean for their portfolio. So far, the possibility of a world war has not caused panic in the markets. It is true that for some time now fear has dominated investors more than greed. Bond prices have seen sharp swings, even for supposedly “risk-free” US Treasuries, and yields have been rising for most of this year. Stock indexes in America, China and Europe have recorded declines for three consecutive months. However, this ruckus can be plausibly explained by peacetime factors, including outsized government borrowing, interest rate expectations and shareholders who have tempered their earlier optimism.
In short, today is nothing like the panic that one might have expected as the chances of the world plunging into another world war grew. The most brilliant conclusion is that such probabilities are really close to zero. A darker one is that, like the investors of 1914, today's may soon be blindsided. History points to a third possibility: that even if investors expect a major war, there is little they can do to reliably profit from it.
What would you do in… 1914?
The easiest way to understand this is to imagine yourself in 1914, knowing that the first world war was about to arrive. You will need to review your investments quickly—within weeks, as the main stock exchanges in London, New York and continental Europe will be closed and this will remain the case for months. Could you guess how many and which way the war might have turned by then? If you wisely judged US stocks as a good bet, would you have been able to trade with a stockbroker who avoided bankruptcy in the midst of a liquidity crisis? Would you have guessed that Russian bonds, which would have seen the October revolution and bankruptcy under the leadership of the Bolsheviks, would be the ones to dump completely?
War, in other words, involves a level of radical uncertainty far beyond the calculable risks to which most investors are accustomed. This means that even previous world wars offer limited lessons for later ones, since no two wars are alike.
Mr. Ferguson's study shows that the optimal compass of 1914 (buying commodities and US stocks, selling European bonds, stocks and currencies) was of little use in the late 1930s. Investors in that decade tried to learn from history . Anticipating another world war, they sold continental European stocks and currencies. But this different war had different profitable investments. British stocks outperformed US stocks, as did British government bonds.
Today there is a greater and more formidable source of uncertainty, as many of the potential belligerents possess nuclear weapons. However, in one sense, this is of little financial importance, since in a nuclear flare-up your portfolio performance is unlikely to rank among your priorities. The result of all this? That the fog of war is even thicker for investors than it is for army generals, who at least see the action. If the worst happens, future historians may marvel at the apparent carelessness of today's investors. They will succeed only because, for them, the fog will have cleared.
