Investing During Wartime: A Realist's Guide

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Given Israel's attack on Iran last week, I thought I'd post the survival guide below on how I deal with such situations as an investor and trader.

In my experience, most of these people peddle doom and gloom that makes for great headlines but is usually terrible for your portfolio. I get it… when missiles are flying, everyone wants to sell everything and hide under a rock. That's usually the wrong move.

This survival guide isn't specific to any particular crisis but is based on an analysis of empirical literature on the impact of wars, civil wars, terror attacks, and similar events. I'll only deal with stock markets here in the U.S., rather than the many different asset classes that feel the influence of geopolitical events.

Don't Panic

The most important rule during a geopolitical crisis is not to panic. The evidence is extremely clear on one thing: the vast majority of geopolitical events don't matter for equity market performance over investment horizons of one month or longer.

On average, the correct response to a geopolitical crisis is to buy risky assets as they sell off.

Four Questions to Ask

Question 1: Infrastructure Impact

Is critical infrastructure in your investment region damaged or destroyed?

Examples: Ports, railways, communication networks, power grids

If yes:

• Expect significant GDP and earnings growth hits for affected companies

• Avoid infrastructure operators and companies dependent on damaged systems

• Insurers face substantial claims (unless they can declare force majeure)

• Opportunities in reconstruction: construction companies, telecom, technology hardware

• Shift to defensive sectors with resilient earnings: healthcare, consumer staples

If no: Move to question 2.

Question 2: Persistent Inflation Impact

Will the crisis create sustained inflation pressure lasting over one year?

Examples: Major oil/gas supply disruptions, substantial war financing expenditures

If yes:

• Invest in inflation beneficiaries: energy companies, defense contractors, gold miners

• Avoid low-margin businesses sensitive to input costs: consumer goods, most industrials

• Prefer companies with stable earnings and lower financial leverage: pharmaceuticals, regulated utilities, tobacco, essential consumer services

• In DCF models: increase inflation assumptions, lower earnings growth expectations due to margin compression

Important: Equities provide inflation protection only up to roughly 4% inflation. Beyond that, businesses can't pass through cost increases fast enough, leading to margin compression and declining earnings growth.

If no: Move to question 3.

Question 3: Real Interest Rate Impact

Will the crisis persistently affect real interest rates for over one year?

Examples: Central bank policy changes, government financial repression

If yes:

• Prepare for increased cost of capital and demand slowdown

• Expect broader market decline and potential bear market

• Under financial repression: particularly bad for banks and insurance

• Under rate hikes: short-term positive for banks and insurance (improved margins)

• Avoid high-leverage companies with debt refinancing needs in next 1-3 years

• Paradoxically, traditional defensive companies (pharma, utilities) may be vulnerable due to high debt levels

• In DCF models: increase real rate assumptions, lower earnings growth expectations

If no: Move to question 4.

Question 4: Pure Risk Premium Effect

Have you answered "no" to all previous questions?

If yes: I “buy the dip.” The geopolitical freak out only affects equity risk premiums without fundamental economic impact. These risk aversion swings typically last days to weeks. This is just fear driving prices down temporarily while the underlying businesses remain unchanged.

A note on hedging: I typically hedge with VIX products instead of shorting the market in situations like these. If I'm wrong, the VIX doesn't move much against my position. If I'm right, the VIX spikes massively and creates a nice asymmetrical risk-reward setup.

$VXX ( ▼ 0.02% ) is usually my go to.

What History Shows

Historical precedent:

• 9/11 attacks: Three-week recovery period after markets reopened

• London bombings: One-day impact—markets recovered to only -1.4% down by close

• Initial Russian invasion of Ukraine: Ten-day recovery to pre-invasion levels

Every crisis plays out differently. Take 9/11—> they actually had to shut down markets for almost a week because the financial district was basically a disaster zone. When trading finally resumed, the Dow immediately tanked 7.1% and kept falling from there.

The London bombings were totally different, markets dropped hard at first, but by the end of that same day, they'd bounced back to only about 1.4% down.

The Ukraine invasion… that has been all over the map depending on where you were, but the pattern was similar. Initial panic, then things started sorting themselves out over the following weeks.

Each time, the people who kept their heads while everyone else was losing theirs made out like bandits.


Disclosure: Always conduct your own research and consult with a financial advisor before making investment decisions. This analysis reflects Pivot and Flow’s views and isn’t personalized advice. All investments carry risk, including complete loss of principal.

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