What Actually Happens to Stock Markets When War Begins

A data-driven examination of market behaviour across a century of armed conflict, the war puzzle, asset class rotations, sector dynamics, and what history tells investors about navigating geopolitical crises.

The Question Every Investor Asks When Conflict Erupts

The news breaks. A border is crossed. A missile is fired. An invasion is announced. Within minutes, trading screens flash red. Within hours, financial commentators are predicting catastrophe. Within days, sometimes within hours, markets are doing something entirely unexpected. They are recovering.

This is not a modern phenomenon. It is not a quirk of algorithmic trading or the product of central bank intervention. It is a pattern that recurs across more than a century of documented market data, spanning World War I, World War II, Korea, Vietnam, the Gulf Wars, Afghanistan, Iraq, and Ukraine. The pattern is counterintuitive, sometimes paradoxical, and consistently misunderstood by investors who react to the headlines rather than the historical evidence.

The central finding of that evidence synthesised by researchers at the Swiss Finance Institute and documented across multiple conflict cycles is deceptively simple: markets fear uncertainty more than they fear war itself. As The Motley Fool’s analysis of wartime markets summarises, the historical record shows that stock markets often dip in the lead-up to wars but rise after they begin, small-cap stocks tend to outperform during conflict, and surprise wars trigger sharper declines than anticipated ones.

Understanding why this happens and what it means for portfolio construction during periods of geopolitical tension is the purpose of this chapter. It draws on data from five major conflicts, examines the behaviour of equities, commodities, currencies, and safe-haven assets, and extracts the investment principles that survive across vastly different historical contexts. The goal is not to trivialise the human cost of war but to provide investors with an analytically grounded framework for navigating its financial consequences.

The War Puzzle: Why Markets Often Rise When Fighting Starts

The most counterintuitive finding in the academic literature on war and financial markets is the one researchers at the Swiss Finance Institute named ‘the war puzzle.’ Put simply, war is terrible news for humanity, yet it is frequently followed by equity market rallies. How can this be?

As Cooke Wealth Management’s analysis of the war puzzle explains, the study found that stock prices generally decline as the likelihood of war increases. However, once war officially begins, markets often rebound rather than fall further. Conversely, when conflict begins unexpectedly without a build-up period, markets tend to drop sharply.

The explanation lies in the fundamental nature of what markets are pricing. Markets are not moral actors; they do not reward or punish nations for their geopolitical choices. They are uncertainty-pricing mechanisms. Every asset price reflects a probability-weighted assessment of all possible future states. When war is approaching but not yet declared, the range of possible futures is enormous: the conflict might be averted, it might be limited, it might escalate, it might draw in additional powers. That enormous range of possibilities creates enormous uncertainty, and uncertainty is precisely what markets dislike most.

Once war begins, that probability range collapses. The worst-case conflict has materialised. The range of remaining uncertainties narrows: how long will it last? What will the economic disruption be? Which sectors benefit and which suffer? These are difficult questions, but they are quantifiable questions. Markets can build models around them. The existential ambiguity of the pre-war period is replaced by the analytical ambiguity of a conflict in progress, and analytical ambiguity is something markets handle far better.

As The Motley Fool concludes based on the Swiss Finance Institute research: ‘Markets don’t fear war; they fear uncertainty. Even messy or prolonged wars can bring enough clarity to ease investor anxiety and stabilise markets.’ This observation reframes everything. The investor who sells equities when war begins is not protecting against the worst outcome; the worst outcome has already materialised. They are selling into the moment when the pricing of that outcome is often most complete.

World War II: The Clearest Historical Illustration

No conflict better illustrates the counterintuitive relationship between war and markets than the Second World War, the most destructive conflict in human history and, paradoxically, one of the most instructive episodes in the history of market psychology.

When Hitler invaded Poland in September 1939, triggering the formal beginning of World War II, the response of the US stock market was not panic. According to Nedbank Private Wealth’s historical market analysis, the US stock market climbed 10% following the invasion. This is the war puzzle in its starkest form: the deadliest war in history begins, and equities rise.

The reasoning reflects the uncertainty-reduction dynamic described above. By September 1939, the geopolitical deterioration of Europe had been visible for years. Hitler’s annexation of Austria in 1938, the occupation of Czechoslovakia, and the sustained escalation of diplomatic tensions had created an extended period of pre-war uncertainty that was far more damaging to markets than the event that finally resolved it. When war began, investors could finally model the situation. They could assess which industries would benefit from wartime production, which supply chains would be disrupted, and what the probable duration of the conflict was. That analytical clarity drove buying.

Pearl Harbour on December 7, 1941, the surprise attack that brought the United States directly into the war produced a sharply different initial reaction. The Dow Jones Industrial Average dipped 2.9% in the immediate aftermath. Critically, however, it recovered within a month. This is the surprise war pattern: a sharper initial decline because there was no pre-war uncertainty period to absorb the shock, followed by an equally rapid recovery as the new reality was priced into the market.

Perhaps the most remarkable data point is the Dow’s performance across the entire conflict. By the time World War II ended in 1945, the Dow Jones had risen approximately 50% from its wartime lows. An investor who sold equities in September 1939 out of fear of global destruction sold at or near the point of maximum uncertainty and missed one of the most significant equity rallies of the 20th century.

US Equity Market Performance: Key Conflict Events  Historical Data

Conflict / Event	Initial Market Reaction	Recovery Timeline	DJIA Performance Over Full Conflict
World War II: Hitler invades Poland (1939)	+10% (US market rose)	Already elevated	+50% by war’s end (DJIA)
World War II  Pearl Harbour (1941)	-2.9% initial decline	Recovered within 1 month	Part of a broader wartime rally
Korean War  Invasion (1950)	Sharp initial sell-off	Recovered within weeks	+60% over conflict period (S&P)
Vietnam War, Gulf of Tonkin (1964)	Mild initial dip	Rapid recovery	The market largely rose during the early conflict
9/11 Attacks (2001)	-14% in first week (S&P)	Recovered within ~1 month	Part of the dot-com era decline (unrelated)
Iraq War  Invasion (2003)	Markets rallied into the invasion	Immediate upward move	+25% S&P in first year of conflict
Russia-Ukraine  Invasion (2022)	Sharp initial decline	Partial recovery within weeks	Broader macro factors dominated in 2022

The Korean and Vietnam Wars: Confirming the Pattern

The Korean War, which began with North Korea’s surprise invasion of South Korea on June 25, 1950, provides another vivid illustration of the surprise-war dynamic. The initial market reaction was a sharp sell-off, consistent with the pattern for unexpected conflicts. The invasion had not been widely anticipated, giving markets no pre-war uncertainty period to absorb the shock gradually.

Yet the recovery was swift. Within weeks, markets had stabilised and begun to recover. Over the full course of the Korean War, the S&P 500 delivered strong positive returns. According to Invesco’s historical analysis of wartime markets during five major conflicts studied, 60% of the time, stock markets rose during the first year. The S&P 500 and Dow Jones Industrial Average performed extremely well during the Korean, Vietnam, and Iraq wars.

The Vietnam War produced a more complex market narrative, partly because the conflict was so prolonged and because it coincided with significant domestic economic turbulence, including the breakdown of the Bretton Woods monetary system and the oil price shocks of the early 1970s. However, the initial market reaction to the Gulf of Tonkin incident in 1964, which dramatically escalated US involvement, was relatively muted, consistent with the anticipated-conflict pattern.

Furthermore, both Korea and Vietnam illustrate a key dimension of wartime market behaviour that goes beyond the simple ‘up or down’ question: wartime economies tend to generate significant sector rotation. Industries directly linked to military production, aerospace, defence, manufacturing, and materials frequently outperform during conflict periods, while sectors dependent on international trade, tourism, and consumer confidence often underperform. Understanding this rotation is as important to portfolio management as understanding the direction of the overall index.

Asset Class Behaviour During Wartime: Beyond Equities

Equity indices capture only part of the wartime financial picture. The behaviour of other asset classes, commodities, government bonds, currencies, and alternative safe havens reveals the full complexity of how capital moves during conflict. Each class responds to different dimensions of wartime economic reality.

Gold: The Oldest Safe Haven. Gold’s role as a safe-haven asset during geopolitical crises is among the most consistent patterns in financial history. When uncertainty surges, investors seek assets that are not denominated in any single currency, are not dependent on any single government’s credit, and have intrinsic scarcity that cannot be inflated away. Gold meets all three criteria.

The data from Invesco’s wartime markets analysis is instructive. At the beginning of the Afghanistan conflict, following the 9/11 attacks, gold prices rose considerably as uncertainty surged. Spot prices for the precious metal increased by 9.0% during the first year of the conflict. This reflected investors’ flight to assets that provide value protection independent of equity market performance.

However, gold’s safe-haven premium tends to be temporary. Once the scope of a conflict becomes clearer and markets stabilise, gold often gives back a portion of its initial gains as risk appetite returns and capital flows back to higher-yielding assets. The investor who rotates to gold as a crisis hedge needs a clear thesis about when to rotate back; otherwise, they risk holding an asset that has peaked at maximum uncertainty and will underperform as uncertainty resolves.

Oil and Energy Commodities. The relationship between war and oil prices is more nuanced than it first appears. The most significant oil price impacts occur when conflicts involve major hydrocarbon-producing regions, such as the Middle East, Russia, and the Caspian basin. Wars in these regions directly threaten supply chains, production infrastructure, and export routes in ways that immediately translate into price pressure.

The Afghanistan war, beginning in late 2001, coincided with a dramatic surge in oil prices. According to Invesco’s analysis, WTI crude oil increased by 31.3% during the first twelve months of the Afghanistan conflict. The Iraq War produced similar dynamics, with energy markets rising sharply as the conflict threatened the stability of one of the world’s largest oil producers. Russia’s invasion of Ukraine in 2022 produced the most dramatic near-term energy price shock since the 1970s oil crisis, given Russia’s dominant role in European natural gas supply.

Importantly, oil price surges during conflict are a genuine economic threat; they create inflationary pressure, compress consumer spending, and increase input costs across virtually every sector of the economy. This transmission mechanism connects geopolitical events to macroeconomic outcomes in ways that affect asset prices well beyond the energy sector.

Asset Class Performance Patterns Across Major Conflict Periods

Asset Class	Pre-War (Uncertainty Phase)	War Onset (First 30 Days)	Established Conflict (6–12 Months)	Post-Conflict
US Equities (S&P 500)	Declining  uncertainty premium	Sharp drop (surprise) or stable/rising (anticipated)	Often positive if conflict is geographically distant	Rally as reconstruction spending begins
Gold	Rising  fear premium building	Spike on initial uncertainty	Elevated but often plateaus	Declines as uncertainty resolves
Crude Oil	Rising if conflict near energy regions	Spike if supply threatened	Sustained elevation if conflict is ongoing	Normalises as supply routes adjust
US Treasury Bonds	Rising prices (yield decline), flight to safety	Peak safety demand	Gradual normalisation	Yields rise as risk appetite returns
USD (Dollar Index)	Strengthening  reserve currency demand	Peak strength on acute uncertainty	Remains elevated during prolonged conflict	Gradual weakening as risk-on returns
Defence Equities	Rising  anticipatory buying	Continued rally	Sustained outperformance	Pullback as contract cycle peaks
Consumer Discretionary	Declining  confidence erosion	Weak / declining	Weak  spending diverted	Recovery post-conflict

Government Bonds and the Flight to Safety

Government bonds, particularly US Treasuries, play a specific and predictable role in wartime capital allocation. When geopolitical risk surges, institutional investors seeking capital preservation rotate out of equities and into the deepest, most liquid government bond markets. The US Treasury market, backed by the world’s reserve currency and offering the deepest liquidity of any fixed-income market, is the primary destination of this flight-to-safety capital.

This flight to safety drives Treasury prices higher and yields lower. For bond investors, this is a positive return event, as the bonds they hold appreciate as new buyers bid up prices. For equity investors, it represents a withdrawal of capital from risk assets that creates or amplifies the equity sell-off that typically accompanies the initial phase of a conflict.

The magnitude of the flight to safety depends heavily on the character of the conflict. Wars that directly threaten the global financial system, a conflict involving a major G7 economy, a nuclear escalation risk, or a conflict disrupting the dollar-based settlement infrastructure, produce the most dramatic Treasury rallies. Regional conflicts with limited global economic impact produce more modest safe-haven flows.

Furthermore, the duration of the flight-to-safety premium is typically short. Once the initial shock is absorbed and the scope of the conflict becomes clear, investors begin to assess whether the low yields offered by safe-haven bonds adequately compensate for the purchasing power risk, and capital gradually flows back to higher-yielding assets. This rotation from bonds back to equities is often the technical driver of the equity market recovery that occurs in the weeks and months following a conflict’s onset.

Tools like the CBOE Volatility Index (VIX), sometimes called the ‘fear gauge’, provide a real-time measure of this uncertainty premium. VIX spikes during conflict events and typically reverts toward its historical mean as the situation stabilises. Monitoring VIX alongside equity price moves gives investors a more complete picture of market psychology than price alone.

Currency Markets During Conflict: The Dollar’s Dominant Role

Currency markets are perhaps the fastest-moving financial markets during geopolitical crises, and they reveal important information about relative confidence in different economies and monetary systems. The patterns that emerge are consistent and instructive.

The US dollar almost universally strengthens during major geopolitical crises. This reflects the dollar’s unique status as the world’s primary reserve currency, the currency in which most international trade is settled, most commodity prices are denominated, and most sovereign foreign exchange reserves are held. When global uncertainty rises, demand for dollars rises with it, as investors and governments seek the liquidity and credibility that dollar holdings provide.

This dollar-strengthening dynamic has important second-order effects. A stronger dollar creates financial tightening for the many countries and corporations that borrow in dollars but earn revenue in local currencies. It reduces the dollar-translated earnings of US multinationals. It puts pressure on emerging market currencies and sovereign debt. These effects can amplify the economic disruption caused by the conflict itself, even for countries far from the physical battlefield.

Conversely, currencies of conflict-adjacent countries tend to weaken sharply. The Russian rouble’s dramatic decline following the 2022 Ukraine invasion, briefly losing more than 30% of its value against the dollar in the immediate aftermath, illustrates the currency consequences for a country directly involved in conflict and subject to financial sanctions. Currencies of neighbouring countries that face refugee flows, trade disruption, and proximity risk also weaken, though typically less dramatically.

For the informed investor, currency market movements during conflict periods provide early signals about which economies are absorbing the greatest risk premium and which are serving as beneficiaries of capital flight. The Bloomberg Dollar Spot Index and currency pairs involving conflict-adjacent economies are among the most information-rich real-time indicators during geopolitical crises.

Defence Sector Dynamics: Who Benefits From Conflict

No sector responds to the onset of conflict more predictably or more immediately than the defence industry. The logic is obvious: war creates government demand for military hardware, technology, logistics, and intelligence services. That demand flows directly to defence contractors, aerospace manufacturers, and military technology companies. Their revenues rise, their order backlogs grow, and their stock prices typically follow.

The phenomenon is consistent across conflict cycles. Defence and aerospace equities tend to outperform the broader market in the period surrounding conflict onset, both because of direct earnings expectations and because of the longer-term implications military spending tends to remain elevated for years after a conflict begins, as governments rebuild depleted inventories and upgrade capabilities in light of new threats.

Companies like Lockheed Martin, Raytheon Technologies, Northrop Grumman, BAE Systems, and Leonardo, among the world’s largest defence contractors, typically see their valuations rise when geopolitical tensions escalate, as markets price in increased government procurement. Exchange-traded funds like the iShares US Aerospace and Defence ETF (ITA) provide diversified exposure to this sector without single-stock concentration risk.

However, defence sector investing during conflict carries important caveats. Order backlogs do not always translate into revenue as quickly as equity markets anticipate; procurement cycles are long, and contracts are complex. Conflicts that end sooner than expected can reverse the earnings trajectory sharply. And the ethical dimension of profiting from military conflict is a consideration that increasingly features in institutional investment mandates through ESG screening frameworks.

Furthermore, the defence sector’s outperformance is most pronounced in the early stages of a conflict. As the conflict progresses and the initial surge in procurement expectations is priced in, the marginal news value of additional military spending declines. Investors who rotate into defence at the onset of conflict and hold through the established-conflict phase often see diminishing returns as the narrative ages.

The Energy Sector: Conflict’s Most Consistent Beneficiary

If defence is the most predictable beneficiary of conflict onset, energy is the most consistently impactful. The relationship between geopolitical instability and energy prices has been a defining feature of global economics since the first oil crisis of 1973, and it remains as relevant today as it was then.

The mechanism is supply risk. Major hydrocarbon-producing regions, such as the Persian Gulf, Russia, and Central Asia, are also among the most geopolitically volatile. Any conflict that threatens production facilities, export pipelines, or shipping routes in these regions creates immediate supply uncertainty that drives spot prices higher. Markets do not wait for actual supply disruption to materialise; they price the probability of disruption into futures contracts immediately, creating price increases that precede any physical supply shortfall.

The Russia-Ukraine conflict of 2022 provided the most dramatic recent illustration. Russia is one of the world’s largest producers of natural gas and a significant crude oil exporter. European economies were heavily dependent on Russian gas through the Nord Stream pipeline system. When the invasion began, and Western sanctions threatened Russian energy exports, European natural gas prices spiked to historically extreme levels. The TTF natural gas benchmark, the primary European natural gas pricing reference, surged by multiples of its pre-crisis level at its peak.

Energy companies with production assets outside conflict zones, and particularly those positioned to supply markets disrupted by the conflict, benefit from this supply shock directly. The 2022 energy price surge was extraordinarily profitable for US LNG exporters, North Sea producers, and Middle Eastern national oil companies whose export routes were unaffected by the conflict. This geography-of-benefit dynamic is a consistent feature of energy market responses to conflict.

Investors seeking energy sector exposure during periods of geopolitical tension can access this through major integrated oil companies like ExxonMobil and Shell or through energy-focused ETFs. However, the timing sensitivity of energy trades around conflict events is extremely high prices can move dramatically in hours and can reverse just as quickly when diplomatic developments change the supply outlook.

Sector Performance Tendencies at Conflict Onset

Sector	Typical Conflict-Onset Direction	Driving Mechanism	Duration of Effect	Key Risk to Thesis
Defence & Aerospace	Strongly positive	Government procurement surge expectation	12–24 months	Rapid conflict resolution; ESG exclusion
Energy / Oil & Gas	Positive (if near energy regions)	Supply disruption fear premium	Weeks to months	Diplomatic resolution; demand destruction
Gold Mining	Positive	Gold price increase transmission	Short to medium term	Gold price reversal
Cybersecurity	Positive	State-sponsored cyber attack expectations	Sustained	Budget allocation uncertainty
Consumer Discretionary	Negative	Confidence erosion; spending shift	Months to years	Stimulus programmes offsetting impact
Airlines / Tourism	Negative	Travel disruption; fuel cost surge	Conflict-duration dependent	Air corridor normalisation
Financials / Banks	Mixed / slightly negative	Credit risk, sanctions exposure	Months	Interest rate offsetting effects
Technology (non-defence)	Mixed	Global trade disruption; supply chain risk	Short to medium term	Remote work demand is offsetting

Surprise Wars vs Anticipated Conflicts: Why the Distinction Matters

The distinction between surprise conflicts and anticipated conflicts is not merely historical trivia; it has direct and immediate implications for portfolio positioning and risk management. Understanding which type of conflict you are facing shapes the expected magnitude and duration of the initial market disruption.

Anticipated conflicts are those where the geopolitical build-up has been visible for weeks or months before the first shots are fired. In these cases, markets have had time to gradually reprice risk. By the time conflict begins, a significant portion of the negative impact has already been absorbed through the pre-war uncertainty discount. The onset of actual fighting can, paradoxically, represent a relief; the feared worst case is now the known present case, and the pricing can become more precise.

The lead-up to the 2003 Iraq War illustrates this pattern clearly. The US military build-up in the Gulf was visible and extensively covered for months before the invasion. Equity markets weakened through the pre-war period and then rallied sharply when the invasion began, not because investors welcomed the war, but because the uncertainty that had depressed prices was replaced by the more manageable uncertainty of a conflict already in progress.

Surprise conflicts are categorically different. The bombing of Pearl Harbour in 1941, North Korea’s invasion of the South in 1950, the 9/11 attacks in 2001, and the initial Russian invasion of Crimea in 2014 all share the characteristic of no meaningful pre-event uncertainty period. Markets had not had time to absorb the risk gradually. The entire price adjustment had to occur in the immediate aftermath, producing sharper initial declines.

However, even in surprise conflict scenarios, the historical pattern of rapid recovery reasserts itself. The specific case of 9/11 is particularly instructive: markets fell 14% in the week following the attacks, the largest weekly decline in decades at that point, and yet recovered to pre-attack levels within approximately one month. As Cooke Wealth Management notes, investors who had experienced prior crises were equipped to remain calm during new events, confident in the market’s long-term recovery potential.

The 9/11 Market Response: A Modern Case Study

The September 11, 2001, terrorist attacks on the United States represent one of the most comprehensively documented cases of market response to a catastrophic surprise event in the modern era. The attacks occurred while US markets were closed, giving the world two days to absorb the initial shock before trading resumed on September 17.

When markets opened on the 17th, the sell-off was severe. The Dow Jones Industrial Average fell 7.1% on the first day of trading. The S&P 500 fell approximately 14% over the first week. These were dramatic numbers. They were also, in hindsight, a near-perfect buying opportunity for investors with a multi-month time horizon.

The recovery was remarkably swift. Within a month, the major US equity indices had largely recovered to pre-attack levels. Several factors drove the speed of recovery. The Federal Reserve moved quickly to provide liquidity and signal support. Congress passed emergency stimulus measures. The scope of the attack, devastating as it was, became clearer over the following days, and investors concluded that while it would have significant economic consequences, it was not the systemic threat to the financial system that the initial panic suggested.

Furthermore, the 9/11 episode illustrated the sector rotation dynamic with particular clarity. Airlines, travel companies, hotels, and casinos, all directly affected by the collapse in travel demand, underperformed severely and for a sustained period. Defence companies, intelligence technology providers, and security firms surged as the scale of the government response became clear. Insurance companies faced severe claims but ultimately recovered as the scale of industry losses was quantified and reinsured.

The 9/11 aftermath also produced one of the first significant tests of cybersecurity as an investment theme. Awareness of the vulnerabilities in critical infrastructure, including financial systems, drove government and corporate investment in security technology that created a sustained growth dynamic for that sector through the decade that followed.

Ukraine 2022: A Conflict That Defied Some Historical Patterns

Russia’s full-scale invasion of Ukraine in February 2022 provides the most recent major test of the historical war-market patterns, and it produced results that both confirmed and complicated the traditional narrative.

The invasion was, in one sense, anticipated. Western intelligence agencies had publicly warned of a Russian military build-up for weeks before the invasion. European and US governments had issued explicit warnings about the likelihood of invasion. This pre-event information period gave markets some opportunity to price in risk consistent with the anticipated-conflict pattern and initial market declines, which were not as catastrophic as initially feared.

However, the conflict also triggered the most aggressive Western sanctions regime ever imposed on a major economy. Russia’s removal from the SWIFT international payment system, the freezing of the Russian Central Bank’s foreign reserves, and sweeping trade restrictions created financial disruptions without a clear historical precedent. The Russian financial system experienced severe stress, and Russian assets, equities, bonds, and the rouble became effectively uninvestable for most international institutions.

The energy price shock from the Ukraine war was also more severe than most historical conflicts had produced, partly because of Europe’s extraordinary dependence on Russian gas and partly because the war began while global energy markets were already tight following pandemic-era underinvestment. European inflation surged to levels not seen since the 1970s, central banks were forced into aggressive rate-hiking cycles, and the combination of energy shock and monetary tightening drove a broad equity market decline throughout 2022 that was only partly attributable to the conflict itself.

Disentangling the conflict effect from the monetary policy effect in the 2022 market performance is extremely difficult, which illustrates a broader analytical principle. Wars do not occur in economic vacuums. Their market impact is always shaped by the pre-existing macro environment, the monetary policy response, and the fiscal capacity of governments to buffer the economic disruption. Analysts who attribute all of 2022’s equity market weakness to the Ukraine war are committing the same analytical error as those who attribute none of it to the conflict.

Psychological Dimensions: How Investor Behaviour Shapes Market Reality

Financial market behaviour during conflict is not just a function of fundamental economic impact; it is equally a function of investor psychology. Understanding the psychological mechanisms that drive wartime market behaviour is essential for investors who want to avoid the most costly behavioural traps.

The most damaging trap is recency bias, the tendency to extrapolate current conditions indefinitely into the future. When markets are falling sharply at conflict onset, recency bias tells investors that further falls are inevitable and that selling now prevents worse losses later. The historical record directly contradicts this intuition: across most conflict scenarios, the moment of maximum fear has coincided with or closely preceded market bottoms, not with midpoints of decline.

As Nedbank Private Wealth’s historical analysis observes, once the fog begins to lift, history shows that markets recover often faster than expected. The investor who allows recency bias to drive selling into crisis conditions consistently realises the loss that the short-term market movement suggests but misses the recovery that history indicates is the far more probable subsequent outcome.

Loss aversion, the well-documented tendency to weight potential losses more heavily than equivalent potential gains, amplifies this problem. The emotional experience of a 5% portfolio decline is approximately twice as intense as the emotional experience of a 5% gain, according to foundational research by Kahneman and Tversky. In wartime conditions, when the downside scenario feels existentially threatening, loss aversion can drive investors to make portfolio decisions that are emotionally rational but financially destructive.

The antidote to both traps is the same: historical perspective and pre-committed investment discipline. Investors who have studied the historical record of market performance during conflict and who have established in advance the conditions under which they will and will not act are far better equipped to navigate acute uncertainty without making decisions they will subsequently regret. As IG Markets’ analysis notes, experienced traders know that markets often look beyond the immediate drama of conflict, and capital flows return to normal patterns once the direction of a war becomes clearer.

Portfolio Positioning During Geopolitical Tension: A Framework

Given the historical patterns documented in this chapter, what does an analytically grounded portfolio positioning framework look like during periods of rising geopolitical tension and conflict onset?

Before conflict onset (rising tensions, pre-war uncertainty): History suggests this is the most damaging period for equity markets, not the conflict itself. If rebalancing is appropriate, modest reductions in emerging market equity exposure (particularly in conflict-adjacent regions) and modest increases in safe-haven assets (gold, short-duration government bonds) provide genuine portfolio protection during this phase without requiring a full defensive posture.

At conflict onset (first days and weeks): The most common mistake is panic selling into the initial decline. Historical evidence consistently shows this is not the optimal response. Maintaining existing equity positions and, for investors with cash available, using conflict-onset volatility to acquire quality assets at discounted prices has historically been the superior strategy. Defence sector overweight and energy sector overweight are the sectors most consistently supported by historical evidence.

Established conflict (months 1–12): As the scope and likely duration of the conflict become clearer, portfolio positioning should reflect the sector dynamics described earlier. Defence, energy, and cybersecurity overweights tend to remain supported. Consumer discretionary and airline sector underweights may be appropriate if the conflict is geographically proximate to major markets. Safe-haven holdings can be gradually reduced as uncertainty resolves.

Post-conflict: Historical evidence suggests that reconstruction spending following major conflicts can be a significant economic stimulus, particularly for industrial, materials, and infrastructure sectors. The post-conflict recovery trade rotating from safe-haven and conflict-beneficiary sectors into reconstruction beneficiaries is one of the more reliable thematic plays in the geopolitical investment cycle.

Throughout all phases, diversification remains the most powerful risk management tool available. Concentrated positions in any single geography, sector, or asset class amplify the impact of geopolitical shocks. A well-diversified portfolio spanning geographies, sectors, and asset classes will experience wartime volatility but will not experience the catastrophic concentration losses that can permanently impair long-term financial outcomes.

Portfolio Positioning Guide by Conflict Phase

Phase	Equity Posture	Sector Tilts	Commodity Exposure	Currency / Bond Adjustments
Rising tensions (pre-war)	Mildly defensive; reduce EM conflict-adjacent	Add defence, reduce travel/leisure	Add gold modestly	Add short-duration government bonds
Conflict onset (days 1–30)	Hold; use volatility to accumulate quality	Overweight defence, energy, cyber	Hold gold; watch oil	Reduce bond overweight as yields fall
Established conflict (1–12 months)	Broadly maintain equity allocation	Maintain defence, energy overweight	Energy-dependent on geography	Gradual normalisation toward neutral
Conflict resolution / post-war	Increase risk posture; add cyclicals	Add industrials, materials, and infrastructure	Reduce gold	Add equities; reduce bond safe-haven premium

Small-Cap Stocks: An Often Overlooked Wartime Outperformer

One of the less intuitive findings from wartime market research is the consistent outperformance of small-cap equities relative to large-cap indices during conflict periods. As The Motley Fool’s wartime stock analysis documents, the historical data on US conflicts show that small-cap stocks tend to outperform during conflict. This finding deserves examination because it runs counter to the intuitive expectation that investors would favour larger, more stable companies during uncertain times.

Several mechanisms explain small-cap wartime outperformance. First, domestic orientation: small-cap companies derive a larger share of their revenues from domestic markets than large multinationals, which means they are less exposed to the global trade disruption that conflicts can cause. Second, agility: small companies can pivot their products and services toward wartime demand more quickly than large, bureaucratically complex organisations. Third, valuation: small-cap equities often enter periods of uncertainty at lower valuations than large-cap peers, providing more margin of safety and more room for recovery.

Additionally, wartime government spending tends to benefit a diverse range of suppliers, not just the prime defence contractors that dominate large-cap indices. Smaller companies in logistics, components manufacturing, specialised technology, and support services often participate significantly in the increased procurement spending without the regulatory and contract scale requirements that limit prime contracts to larger firms.

For investors seeking to express a wartime positioning view through equities, small-cap exposure through indices like the Russell 2000 or sector-specific small-cap defence and industrial funds provides diversified access to this historically documented outperformance pattern.

Long-Term Investor Perspective: History Favours Those Who Hold

Across all the conflict scenarios, asset class behaviours, sector rotations, and psychological dynamics examined in this chapter, one finding stands above all others in its consistency and its practical importance for long-term investors: the market’s long-term trajectory has survived every conflict in modern history intact.

World War I, the deadliest and most economically destructive conflict of the early 20th century, was followed by the roaring 1920s equity boom. World War II, which saw the physical destruction of much of Europe and Asia, was followed by three decades of the strongest economic growth the developed world has ever experienced. Korea, Vietnam, and the Gulf Wars did not derail the long-term upward trajectory of equity markets in the economies that hosted them.

As The Motley Fool’s wartime investment guide summarises with elegant simplicity: ‘In peace and wartime, history favours those who hold.’ This is not naive optimism. It is the empirical finding of a century of data. The investors who sold in September 1939 when Hitler invaded Poland missed the 50% Dow rally by war’s end. The investors who sold in the week after 9/11 missed the full recovery within a month. The investors who sold at the depths of the 2008 financial crisis, the most severe test of the financial system since the Great Depression, missed the subsequent decade-long bull market.

This does not mean all investments survive all conflicts. Individual companies fail. Individual sectors suffer permanent structural damage. Economies that are physically destroyed face decades of reconstruction before returning to pre-war levels. Geographic concentration in conflict zones can produce genuine permanent capital loss. These are real risks that require genuine diversification to manage.

However, for the broadly diversified investor with a time horizon of five years or more, the historical case for maintaining equity exposure through periods of geopolitical tension and conflict is compelling and remarkably consistent. The events that feel most threatening in the moment have, with very few exceptions, proven to be temporary interruptions in long-term value creation rather than permanent impairments of it.

What Chapter 12 Will Cover

This chapter has examined the immediate financial market response to the onset of conflict, the war puzzle, asset class rotations, sector dynamics, and the investor psychology that shapes market reality during acute geopolitical crises. The patterns revealed by a century of data provide a robust framework for portfolio positioning during periods of rising tension.

Chapter 12 will examine the longer-term economic consequences of sustained conflict, the mechanisms through which wars reshape industrial capacity, government debt levels, currency systems, and the competitive positions of nations. It will also address the question of how investors can identify the structural shifts that major conflicts produce, the industries that emerge from war permanently transformed, the geopolitical realignments that create new investment opportunities, and the lessons from post-war reconstruction that apply to portfolio positioning in the years following a major conflict’s conclusion.

Frequently Asked Questions

Does the stock market always recover after wars? Broadly, yes, for diversified investors in the economies hosting the conflict. The historical record across a century of major conflicts shows consistent long-term recovery. However, individual companies and sectors can suffer permanent damage, and geographic concentration in physically destroyed economies involves different risk parameters.

Is it better to sell stocks when war breaks out? Historical evidence strongly suggests no, at least for investors with a medium to long time horizon. Selling into conflict onset has consistently meant selling near or at market lows and missing the subsequent recovery. The exception is high-risk concentration in geographies or sectors directly and severely impacted by the specific conflict.

What is the best asset to hold during wartime? The honest answer depends on the type of conflict, its geographic scope, and the pre-existing macro environment. Gold provides reliable short-term crisis protection but underperforms in the medium term as uncertainty resolves. Defence equities have a strong historical wartime track record. Diversification across asset classes remains the most robust strategy.

Why do defence stocks rise when conflict begins? Because conflict creates direct government demand for military procurement weapons, technology, logistics, and intelligence services. Markets price this demand increase into defence company valuations immediately, often before contracts are formally announced.

How quickly do markets typically recover from war-related sell-offs? In most documented cases, the recovery from the initial conflict-onset sell-off occurs within weeks to months. The 9/11 sell-off recovered within approximately one month. Pearl Harbour’s market impact recovered within a similar period. The more severe the initial shock and the broader the macro disruption, the longer the recovery, but the median recovery period across documented cases is substantially shorter than most investors intuitively assume.

Spend some time for your future. 

To deepen your understanding of today’s evolving financial landscape, we recommend exploring the following articles:

From $300K Startup to EV King: BYD’s Vertical Integration Victory

How Power Laws Predict Bitcoin’s Price Floor

Salary Negotiation Scripts That Actually Work: Data-Backed Strategies for Remote Roles

Value Proposition Design for Tech Startups: From Unmet Need to Scalable Revenue

War Economy Chapter 10: The Cost of Political Ego: When Decisions Override Economics

Explore these articles to get a grasp on the new changes in the financial world.

Disclaimer

This article is intended for general informational and educational purposes only. It does not constitute investment, financial, legal, or professional advice. Historical market performance during periods of geopolitical conflict does not guarantee future results. All investments involve risk, including the potential loss of principal. Readers should consult qualified financial advisors before making investment decisions. The author and publisher accept no liability for investment outcomes arising from reliance on this content.

References

[1] Cooke Wealth Management, ‘How the Stock Market During War Shapes Your Investments’. [Online]. Available: https://www.cookewm.com/blog/investing/stock-market-during-war

[2] The Motley Fool, ‘Wartime and Wall Street: How War Affects the Stock Market’. [Online]. Available: https://www.fool.com/research/how-war-affects-stocks/

[3] Nedbank Private Wealth, ‘How War Affects Markets and What Investors Can Learn from History’. [Online]. Available: https://nedbankprivatewealth.com/insights/how-war-affects-markets-and-what-investors-can-learn-from-history/

[4] Invesco / UNIO Education Series, ‘Markets in War Time’. [Online]. Available: https://www.unio-eb.ie/wp-content/uploads/2022/04/Invesco-Education-Series-Markets-in-time-of-war-Final-002.pdf

[5] IG Markets, ‘How War Affects Markets: Trading During Global Conflicts’. [Online]. Available: https://www.ig.com/en/news-and-trade-ideas/how-war-affects-markets-and-trading-opportunities-during-global–250623

[6] Swiss Finance Institute, ‘Research on Market Performance During Wartime’. [Online]. Available: https://www.sfi.ch/en

[7] CBOE, ‘VIX: The CBOE Volatility Index’. [Online]. Available: https://www.cboe.com/tradable_products/vix/

[8] S&P Global / Dow Jones Indices, ‘Dow Jones Industrial Average’. [Online]. Available: https://www.spglobal.com/spdji/en/indices/equity/dow-jones-industrial-average/

[9] FTSE Russell, ‘Russell 2000 Index’. [Online]. Available: https://www.ftserussell.com/products/indices/russell-us

[10] Kahneman, D. and Tversky, A., ‘Prospect Theory and Loss Aversion’, Econometrica, Vol. 47 No. 2, 1979. Discussion available: https://www.economist.com/economics-brief/2016/07/30/the-beguiling-allure-of-loss-aversion