How War Affects the Modern Stock Market

The world is witnessing a surge of violence and instability, as Hamas fighters launch deadly attacks on civilians in Israel, Russia invades Ukraine, and Iran and North Korea pose nuclear threats. Conflicts and stand-offs like these have global implications, not only for peace and security, but also for the economy and global stock markets. For example, in fiscal year 2022, the U.S. had spent an estimated $8 trillion on post-9/11 wars, a sizable piece of GDP, and a contributor to economic growth in certain sectors.

But how do wars affect the economy and stock markets more broadly? Security experts are weighing in, and only time will tell, but experts remind us that past wars didn't push U.S. equities lower over the long term. How will markets react this time?

Markets Often Shrug It Off

War often brings about a level of uncertainty which markets typically dislike. The outbreak or anticipation of war can lead to a sharp sell-off in stocks. At the same time, investors may move towards traditionally safer assets like gold, bonds, or currencies perceived as safe havens. Despite the initial negative reaction, stock markets have shown resilience over time. Indeed, they often quickly recover as the situation stabilizes or as the scope of the conflict becomes clearer.

LPL Financial research notes that stocks have largely shrugged off past geopolitical conflicts. "As serious as this escalation is, previous experiences have indicated it may be unlikely to have a material impact on U.S. economic fundamentals or corporate profits," said former LPL Financial Chief Investment Strategist John Lynch, referring to the January 2020 U.S. airstrike that killed Iranian general Qasem Soleimani. "We would not be sellers of stocks into weakness related to this event, given stocks have weathered heightened geopolitical tensions in the past."

"From the start of World War II in 1939 until it ended in late 1945, the Dow was up a total of 50%, more than 7% per year. So, during two of the worst wars in modern history, the U.S. stock market was up a combined 115%," wrote Ben Carlson, director of institutional asset management at Ritholtz Wealth Management, in an article about counterintuitive market outcomes. "The relationship between geopolitical crises and market outcomes isn't as simple as it seems."

S&P 500 Index Price From When Russia Invaded Ukraine to a Month Later
Another example is after Russia invaded Ukraine on February 24, 2022, it rattled global markets. In the U.S., the S&P 500 index fell more than 7% in the days and weeks immediately following the incursion, as the U.S. and other nations stepped up severe economic sanctions on Russia and investors worried about the impact of commodity prices. But, a month later markets had rebounded and the S&P was trading at a level higher than before the invasion, even as the price of oil remained elevated above $100 a barrel.

S&P 500 Index Price From the Simchat Torah Hamas Massacre of Israeli Civilians to Several Days After
In the latest conflict between Israel and Palestinian militants, which began by the killing and abduction of more than 1,300 Israeli civilians by Hamas fighters from Gaza on Saturday, October 7, 2023, the S&P 500 sank briefly on the first trading day following these tragic events. But as the Israeli army and air force responded, the S&P actually rose over the following week. Since the conflict involves the Middle East, with the potential for other regional interests to enter the conflict, the price of oil rose moderately from around $83 to $86 per barrel -- but still well below near-term highs of around $94 observed in September 2023.

When Markets Can Suffer

History tells us periods of uncertainty like we're seeing now are usually when stocks suffer the most. In 2015, researchers at the Swiss Finance Institute looked at U.S. military conflicts after World War II and found that in cases when there is a prewar phase, an increase in the likelihood of war tends to decrease stock prices, but the ultimate outbreak of war increases them. However, in cases when a war starts as a surprise, the outbreak of war decreases stock prices. They called this phenomenon "the war puzzle" and said there is no clear explanation for why stocks increase significantly when war breaks out after a prelude. 

Similarly, Mark Armbruster, president of Armbruster Capital Management, studied the period from 1926 through July 2013 and found that stock market volatility was actually lower during periods of war. "Intuitively, one would expect the uncertainty of the geopolitical environment to spill over into the stock market. However, that has not been the case, except during the Gulf War when volatility was roughly in line with the historical average," he said.

In terms of the persistent Iran conflict, however, investors have had a muted reaction to the headlines. "If 2019 taught us anything, it’s that you have to try as best as possible to keep to your process and not get caught up in the headlines," said Strategas Technical Director Todd Sohn to The Washington Post. "In a sad way, I wonder if we’ve become used to it. I wonder if the market has learned to discount these events."  

"Part of the reason for the calm may lie in the changing structure of global oil markets and how the U.S. economy has become less vulnerable to energy price swings," said J.P. Morgan Funds Chief Global Strategist David Kelly in a note. "Part of the reason may be purely psychological. Today’s investors have seen the stock market recover from both 9/11 and the Great Financial Crisis, arguably the greatest geopolitical and economic shocks of our time. This makes it easier for investors to shrug off other events."

A broader conflict with Russia can also cause volatile oil markets, as Russia is a key producer of crude oil and natural gas, with pipelines feeding many parts of Europe. If Russia were to shut off the spigot or suffer significant oil infrastructure damage, it could lead to higher energy prices. Interruptions to the ports around the Black and Baltic Seas could also create even bigger shipping congestion and lead to food inflation as grains and other staples remain stuck at sea.

The Bottom Line

"Over the last few years, markets have been conditioned not to overreact to political and geopolitical shocks for two reasons: first, the belief that there would be no significant subsequent intensification of the initial shock; and second, that central banks stood ready and able to repress financial volatility," said Mohamed A. El-Erian, chief economic adviser at Allianz, in a Bloomberg column.

But he warned that investors buying the dip should use a selective overall strategy. "This includes emphasizing up-in-quality trades that are anchored by robust balance sheets and high cash flow generation, resisting the strong temptation for large-scale shifts away from U.S. assets in favor of international investments and reducing exposure to inherently less-liquid market segments that have experienced beneficial spillovers from extraordinary central bank stimulus and the general reach for yield and returns," he said.