Europe had been heading towards the slaughterhouse for some years, and, in 1914, conflict was almost inevitable; This is, at least, the reasoning that is usually made retrospectively. However, at the time, as historian Niall Ferguson points out in an article published in 2008, investors did not see it that way. For them, the First World War was a shock. Until the week before its start, there were hardly any movements in bond prices, currencies and money markets. And suddenly everything exploded. “The City has suddenly seen the meaning of war,” wrote The Economist on August 1, 1914.
Could financial markets now be undervaluing the risk of global conflict again? In the nightmare scenario, the descent into a third world war began two years ago, when Russian troops massed on the Ukrainian border. Today, Israel's battle against Hamas has the terrifying potential to extend beyond that country's borders. American military support is crucial for both Ukraine and Israel, and in Iraq and Syria the superpower's bases have been attacked, probably by Iranian agents. If China decided that the time had come to take advantage of all that distraction and invade Taiwan, the United States could very easily be dragged into three wars at the same time. The rest of the world runs the risk of these wars intersecting and becoming even more devastating.
Of course, in such a scenario the financial damages would be very low on the list of horrors. Still, it's part of an investor's job to consider exactly what something like this would mean for his or her portfolio. So far, the possibility of a world war has barely caused a tremor in the markets. It is true that they have been guided more by fear than by greed for some time. Bond prices have been turbulent, even for supposedly risk-proof US Treasuries; and returns have not stopped rising for much of the year. Stock indices in the United States, China and Europe have fallen for three consecutive months. However, the unrest can plausibly be explained by peacetime factors; among them, excessive public debt, expectations about interest rates and shareholders who have been overcome by their optimism.
In short, none of this resembles the panic one would expect if the chances of a world war breaking out were increasing. The brightest conclusion is that those probabilities are actually close to zero. There is another darker one; And, like the investors of 1914, today's investors may soon be surprised. 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.
The easiest way to understand it all is to imagine yourself in 1914, knowing that the First World War is about to come. Bets need to be placed quickly; Within a few weeks, the main stock exchanges in London, New York and continental Europe will be closed. And they will remain closed for months. Would we be able to guess which ones (and in what way) the war will have disrupted by then? If we had sensibly considered US stocks to be a good bet, would we have managed to trade with an agent that avoided bankruptcy in the midst of a liquidity crisis? Perhaps we could decide, again sensibly, to cut positions in a public debt that would soon be subjected to the strains of war. Would we have guessed that Russian bonds, which would experience a communist revolution and a Bolshevik-driven default, were the ones to be scrapped entirely?
In other words, war involves a level of radical uncertainty far beyond the calculable risks to which most investors have become accustomed. That means that even earlier world wars offer limited lessons for later ones, because no two wars are the same. Ferguson's article shows that the best guidance in 1914 (buy American commodities and stocks; sell European bonds, stocks, and currencies) was of little use in the late 1930s. Investors of that decade tried to learn from history. Seeing another world war coming, they sold continental European stocks and currencies. However, that different war had different winning investments. British stocks outperformed American stocks, and so did British government bonds.
Today there is a greater and more terrible source of uncertainty, since many of the possible belligerent powers have nuclear weapons. Now, in one sense, that circumstance has little financial relevance, since in a nuclear conflagration portfolio performance is unlikely to be high on our priorities. The final conclusion? That the fog of war is even thicker for investors than for military generals, who at least have a vision of the action. If the worst happens, future historians will be able to marvel at the apparent insouciance of today's investors. And they will be able to do it because, for them, the fog will have lifted.
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Translation: Juan Gabriel López Guix
