Retrospective experts say that war in Europe in 1914 was absolutely inevitable. But at the time, as historian Niall Ferguson notes in a paper published in 2008, investors did not think so, according to The Economist.
The outbreak of the First World War shocked investors. In the week before it began, prices in the bond, currency and money markets were virtually unchanged. Then all hell broke loose.The newspapers wrote on August 1st 1914:
 The City has seen in a flash the meaning of war.
Could financial markets once again underestimate the risk of global conflict developing? In the nightmare scenario, the descent into World War III began two years ago when war broke out in Ukraine. Today, Israel’s struggle with Hamas could spill over beyond its borders and even the entire Middle East. Washington’s military support is crucial for both Ukraine and Israel, and in Iraq and Syria, the superpower’s bases are coming under fire, possibly from Iran’s proxies. If China decides it is time to take advantage of the superpower’s dissipation and increase its influence over Taiwan, America could find itself embroiled in three wars at once. The rest of the world runs the risk that these wars will intertwine with each other and turn into something even more destructive.
In this scenario, few people would worry about the financial damage from the war. However, it is the investor’s responsibility to analyse how it would affect his portfolio. So far, the possibility of a world war has caused little change in the financial markets. Admittedly, they have been gripped more by fear than greed for some time now. Bond prices have been choppy, even for supposedly “risk-free” US Treasuries, and yields have been rising for most of this year. Stock indices in America, China and Europe have fallen for three consecutive months. However, all these fluctuations can well be attributed to peacetime factors, including excessive government borrowing, interest rate expectations and earlier shareholder optimism.
This does not sound like the kind of panic one might expect if the odds of the world plunging into war were getting higher and higher. The brightest conclusion is that such odds are indeed close to zero. The darker one is that, like investors in 1914, today’s investors may soon find themselves blindsided. History points to a third possibility: even if investors expect a major war, there is little they can do to reliably profit from it.
How can one understand it – to immerse oneself in the atmosphere of 1914, knowing that tomorrow the First World War would begin. Bets had to be placed quickly – within weeks the major stock exchanges in London, New York and continental Europe would close for months. Would you be able to guess how much and which way the war might turn by then? If you had sensibly decided that US stocks were a good bet, would you have been able to trade with a broker who avoided bankruptcy in the midst of a liquidity crisis? Perhaps you would decide, again wisely, to short positions in government debt that would soon be threatened by war. Would you guess that Russian bonds that would survive the Communist revolution and the default caused by the Bolsheviks were the bonds that should be dumped entirely?
War is a total uncertainty that goes far beyond the calculated risks most investors are used to. This means that even previous world wars have limited lessons for subsequent ones, as no two are alike. Mr Ferguson’s paper shows that the optimal course of action in 1914 (buy commodities and US stocks; sell European bonds, stocks and currencies) was of little use in the late 1930s. Investors in that decade did try to learn from history. Anticipating another world war, they sold Continental European stocks and currencies. However, in this other war, other investments won. British stocks outperformed American stocks, as did British government bonds.
Modern wars are also dangerous because most of the warring countries possess nuclear weapons. In a sense, however, this doesn’t matter much financially, because in a nuclear conflagration, the performance of your portfolio is unlikely to be at the top of your priorities. The bottom line of all this? For investors, the fog of war is even thicker than it is for military generals, who at least see what’s happening. If the worst happens, future historians may be surprised at the seeming nonchalance of today’s investors. But only because for them the fog has already cleared.
