War is a terrible thing. It causes death, destruction, and suffering for millions of people. It also creates uncertainty and fear for the rest of the world. How will the conflict end? What will be the consequences? How will it affect the global economy and the stock market?

These are some of the questions that investors may ask themselves when faced with a war situation. It is natural to worry about the impact of war on your portfolio and your financial future. However, history shows that war is not always bad for the stock market. In fact, sometimes it can even be good.

In this post, I will explain how war affects the stock market, what are the best investments during times of war, and how you can prepare your portfolio for any scenario.

How War Affects the Stock Market

The stock market hates uncertainty. When there is a threat of war or a sudden outbreak of violence, investors tend to panic and sell their stocks. This leads to a sharp decline in the market, as seen in the chart below:

However, this initial reaction is often short-lived. Once the situation stabilizes or the scope of the conflict becomes clearer, the market tends to recover quickly. Sometimes, the market even rallies during or after a war, as seen in the chart below:

Why does this happen? There are several reasons:

• War stimulates the economy: War can boost economic activity by increasing government spending, creating jobs, and stimulating innovation. For example, during World War II, the U.S. economy grew by an average of 12% per year, as the government spent billions of dollars on war production and employed millions of workers. War can also create new opportunities for businesses, especially in the defense, energy, and technology sectors.
• War reduces uncertainty: War can reduce uncertainty by resolving political or ideological conflicts, creating new alliances, or establishing new order. For example, after the Cold War ended, the world became more peaceful and stable, as the U.S. emerged as the sole superpower and the global leader. War can also create a sense of patriotism and optimism among the people, which can boost consumer confidence and spending.
• War is priced in: War can be priced in by the market, meaning that the market anticipates the outcome and adjusts accordingly. For example, before the U.S. invaded Iraq in 2003, the market had already factored in the possibility of war and the expected victory of the U.S. Therefore, when the war actually started, the market did not react much, as it was already prepared for it. War can also be priced out by the market, meaning that the market ignores the war and focuses on other factors, such as earnings, interest rates, or inflation.

Of course, not all wars are the same. Some wars are more devastating, prolonged, or unpredictable than others. Some wars have more global implications, while others are more localized. Some wars have more direct effects on the U.S. economy and the stock market, while others have more indirect effects. Therefore, the impact of war on the stock market depends on the nature, scale, and duration of the war, as well as the geopolitical and economic context.

What to Invest in During Times of War

Given the uncertainty and volatility that war can create, what are the best investments during times of war? There is no definitive answer to this question, as different wars may have different effects on different sectors and assets. However, here are some general guidelines that may help you:

• Stay diversified: The best way to protect your portfolio from any scenario is to stay diversified across different asset classes, sectors, regions, and styles. By diversifying your portfolio, you can reduce your risk and increase your chances of capturing the opportunities that war may create. For example, you can invest in a mix of stocks, bonds, commodities, real estate, and cash, as well as in different industries, countries, and market segments.
• Invest in defense stocks: Defense stocks are the stocks of companies that produce weapons, equipment, or services for the military. Defense stocks tend to perform well during times of war, as the demand for their products and services increases. For example, during the Iraq War, the S&P Aerospace & Defense Index outperformed the S&P 500 Index by 87%. Some of the largest and most well-known defense stocks are Lockheed Martin, Boeing, Raytheon, and Northrop Grumman.
• Invest in energy stocks: Energy stocks are the stocks of companies that produce or distribute oil, gas, or other forms of energy. Energy stocks tend to perform well during times of war, as the supply of energy may be disrupted or threatened, leading to higher prices. For example, during the Gulf War, the price of oil spiked by 130%, benefiting the energy sector. Some of the largest and most well-known energy stocks are Exxon Mobil, Chevron, BP, and Shell.
• Invest in commodities: Commodities are the raw materials that are used to produce goods and services, such as gold, silver, copper, or wheat. Commodities tend to perform well during times of war, as they are seen as a hedge against inflation, currency devaluation, or market turmoil. For example, during the Vietnam War, the price of gold rose by 455%, as investors sought a safe haven from the weakening dollar and the rising inflation. Some of the ways to invest in commodities are through futures contracts, exchange-traded funds (ETFs), or stocks of commodity producers.
• Invest in cash: Cash is the most liquid and flexible form of money, which can be used to buy goods and services, pay debts, or save for the future. Cash tends to perform well during times of war, as it provides safety, stability, and optionality. For example, during the Korean War, the U.S. dollar appreciated by 12% against the British pound, as investors preferred the currency of the stronger and safer country. Some of the ways to invest in cash are through bank accounts, money market funds, or short-term treasury bills.

How to Prepare Your Portfolio for War

While it is impossible to predict when, where, or how a war will start or end, it is possible to prepare your portfolio for any eventuality. Here are some steps that you can take to make your portfolio more resilient and adaptable to war:

• Review your risk tolerance: Your risk tolerance is your ability and willingness to take risk in your investments. Your risk tolerance may change over time, depending on your age, income, goals, and personal circumstances. War may also affect your risk tolerance, as it may increase your fear, anxiety, or uncertainty. Therefore, you should review your risk tolerance regularly and adjust your portfolio accordingly. For example, if you are more risk-averse, you may want to reduce your exposure to stocks and increase your exposure to bonds, cash, or other less volatile assets.
• Rebalance your portfolio: Rebalancing your portfolio is the process of restoring your portfolio to its original or desired asset allocation. Rebalancing your portfolio can help you maintain your risk level, capture market opportunities, and avoid emotional biases. You should rebalance your portfolio periodically, such as once a year, or when your portfolio deviates significantly from your target allocation. For example, if your portfolio has become more skewed towards stocks due to market movements, you may want to sell some stocks and buy some bonds, cash, or other assets to rebalance your portfolio.
• Diversify your portfolio: Diversifying your portfolio is the process of spreading your investments across different asset classes, sectors, regions, and styles. Diversifying your portfolio can help you reduce your risk, increase your returns, and cope with market fluctuations. You should diversify your portfolio as much as possible, without compromising your risk-return objectives. For example, you can diversify your portfolio by investing in a variety of ETFs, mutual funds, or index funds that cover different segments of the market.

War is a complex and unpredictable phenomenon that can have profound effects on the world and the stock market. However, war is not necessarily bad for your portfolio, as long as you are prepared and adaptable. By following the guidelines above, you can invest wisely and confidently during times of war. Remember, the best defense is a good offense.