Avoiding the Mistake of the Wartime Pivot

Executive Summary

1. The onset of war is not a reliable predictor of asset class performance. Geopolitical conflict does not override market fundamentals.

   
   

2. Starting valuations remain the primary driver of returns. The price you pay matters more than the news cycle.

   
   

3. Variability in sector performance necessitates diversification.

Introduction

During the acute phase of the recent Iran conflict, much was written about “wartime positioning” for investment portfolios. We found ourselves disagreeing with most of it. While we hope the “hot war” phase of this conflict has passed, the impulse to pivot during a crisis remains a recurring mistake for many investors. We share this analysis to provide an evidence-based framework for navigating future periods of conflict.

War, Inflation, and Asset Class Returns

Over the last century, the US has been involved in five major conflicts: World War II, the Korean War, the Vietnam War, the Persian Gulf War, and the “War on Terror” (Iraq/Afghanistan). We study the returns of assets through each one. Though we have excluded the Gulf War from our tables because its combat phase lasted less than 100 days – too short to draw meaningful investment conclusions.

The most consistent economic byproduct of war is inflation. Expanded government defense spending, particularly during extended conflicts, has historically pushed inflation to average ~4% compared to the long-term historical average of less than 3%. While wartime spending can act as a fiscal stimulus, it is a double-edged sword; erosion of purchasing power is the primary “loser” investors must avoid. Note: This historical trend is not a forecast, but a structural risk. If a conflict persists, higher inflation is a high-probability outcome.

When we examine the inflation-adjusted returns for stocks, bonds, and gold, we find a surprising lack of consistency. The table below shows performance during each of the past wars. War in isolation is not a reliable catalyst for any specific asset class. One cannot simply bet on stocks over bonds, or gold over stocks.

Wars	Cash	Treasury Bonds	Gold	US Equities
World War II (1941-1945)	-4.0%	-1.5%	-3.6%	15.9%
Korean War (1950-1953)	-2.2%	-2.6%	-3.7%	10.4%
Vietnam War (1964-1975)	0.5%	-1.2%	10.5%	-1.6%
War on Terror (2001-2011)	-0.6%	3.1%	15.3%	1.7%
Average	-1.6%	-0.6%	4.6%	6.6%

Source: Ken French Data Library, Robert Schiller data, Bloomberg, Greenline Partners analysis

To understand the variance in performance, we must look at valuation.

Expensive Stocks Still Usually Lose

The data reveals a stark contrast in wartime performance. Stocks delivered exceptional returns during World War II and the Korean War but struggled during the Vietnam War and War on Terror. Gold and bonds show similar inconsistencies.

The nuance lies in starting P/E ratios, as a proxy for valuation. When valuations were low at the onset of conflict (e.g. WWII), subsequent returns were high. When P/E ratios were elevated (e.g. War on Terror), returns were muted. The table below highlights this connection.

Wars	Starting P/E	S&P 500 Return	Macroeconomic Context
World War II	7.6	15.9%	Cheap stocks after Depression, war spending kick started the economy
Korean War	7.4	10.4%	Cheap stocks, booming post-WWII economy
Vietnam War	18.5	-1.6%	Expensive stocks, large gov’t deficit spending
War on Terror	22.3	1.7%	Tech stock bubble bursting + debt financed war
Full History Average	16.2	7.2%

  Source: Bloomberg, Greenline Partners analysis

As you will see in the chart below, high valuations provide little margin of safety, making a portfolio vulnerable to the volatility of war, while low valuations on the other hand provide a buffer that allows the underlying stimulus of wartime spending to eventually drive prices higher.

Source: Bloomberg, Greenline Partners analysis

The same logic applies to fixed income. In 2001, bonds entered the conflict with high inflation-adjusted yields and subsequently performed well. In contrast, periods of low starting yields saw bonds struggle to keep pace with wartime inflation.

The Sector Trap: Energy and Defense are Not Reliable Outperformers

If market timing is a “loser’s game”, can we instead win through sector selection? The data suggests otherwise.

The table below shows the returns, again adjusted for inflation, for sectors, through the major wars. We find no evidence of a consistent wartime winner. While the Energy sector outperformed during the Gulf war (an oil-centric conflict during 1990-91), it trailed during World War II and Vietnam.

Sectors	World War II	Korean War	Vietnam War	War on Terror
Staples	23%	6%	5%	9%
Discretionary	31%	17%	1%	2%
Industrials	20%	14%	6%	10%
Energy	16%	23%	5%	13%
Info Tech	25%	14%	5%	5%
Telecom	14%	6%	1%	1%
Shopping	27%	9%	5%	7%
Healthcare	18%	4%	10%	3%
Utilities	30%	12%	0%	9%
Financials	29%	17%	3%	1%

Source: Ken French Data Library, Robert Schiller data, Bloomberg, Greenline Partners analysis

Just as with broad asset classes, sector leadership is driven by valuation. If a sector is cheap, it has the potential to outperform; if it is priced for perfection, even a wartime tailwind will not save it. Because predicting these shifts is notoriously difficult, the most successful strategy is to avoid taking big bets.

What the Data Does Not Show

This study is US-centric which introduces survivorship bias. Every conflict listed was fought on foreign soil and ended without significant damage to US infrastructure. The investing outcomes would likely have been different had this been different.

History shows that for nations where the battle is fought at home, such as Germany or Japan in the 1940s, the outcome was total decimation of their capital markets. Rebuilding takes decades. This is the strongest logical argument for geographic diversification. It is not just a tool for optimizing returns, it is an insurance policy against the tail risk of domestic catastrophe.

Preparing Your Mind and Portfolio

As of this writing, a ceasefire holds with Iran. While we hope for peace, history suggests that uncertainty in the Middle East will remain constant.

From our research, preparing your portfolio for war does not mean pivoting towards defense stocks or gold. It means:

1. Preparing your mind: Accept the volatility and resist the urge to react to headlines.

   
   

2. Preparing your portfolio: Ensure you are diversified across asset classes and geographies and avoid expensive asset classes if possible.

Thoughtful diversification and focus on the long term is a reliable way to prepare your portfolio. Diversify your equities across geographies and your sectors broadly. This is a true time-tested method to preserve and grow wealth through the wide range of economic environments that can result from periods of conflict.

DISCLOSURES: The information contained herein is the property of Greenline Partners, LLC and is circulated for information and educational purposes only. There is no consideration given for the specific investment needs, objectives, or tolerances of any of the recipients. Additionally, Greenline's actual investment positions may, and often will, vary from its conclusions discussed herein based upon any number of factors, such as client investment restrictions, portfolio rebalancing and transaction costs, among others. Reasonable people may disagree about a variety of factors discussed in this document, including, but not limited to, key macroeconomic factors, the types of investments expected to perform well during periods in which certain key economic factors are dominant, risk factors and various assumptions used. Recipients should consult their own advisors, including tax advisors, before making any investment decision. This report is not an offer to sell or the solicitation of an offer to buy the securities or instruments mentioned.