Repost: Survival guide for investors in armed conflict

The procedure should be familiar to every investor by now, especially after the twelve days of airstrikes by the US and Israel in 2025.

The military buildup comes not only as diplomatic efforts to curb Iran’s nuclear capabilities continue, but just a week after Israeli Prime Minister Benjamin Netanyahu visited Trump at the White House, giving the two countries a chance to coordinate their actions in person. Meanwhile, Iran launches a joint naval exercise with Russia off the coast of Oman to demonstrate its own strength. Finally, let us not forget that on Tuesday, Iran closed the Strait of Hormuz for a few hours during a military exercise. In my view, this is more of a stance aimed at countering the US stance rather than a real threat to close the strait for an extended period of time and disrupt global oil supplies.

I think it’s time to revisit my timeless investor’s guide to armed conflict as the best template for investment decisions in the days and weeks ahead.

We live in a world where wars, civil wars and geopolitical tensions are having an increasing influence on the markets. There are plenty of geopolitical advisors ready to help investors with advice, and even more strategists pretending to know how to play the markets at a time of geopolitical tensions.

Geopolitical risk index

Source: Caldaro et al. (2021)

Yet, in my experience, the vast majority of these experts spread doom and gloom, which makes big headlines but is usually bad for investment portfolios. Attract my book on geopolitics for investors And my 2025 update I give investors a survival guide on how to respond to geopolitical crises.

This survival guide is not specific to any particular crisis, but based on an analysis of the extensive empirical literature on the impact of wars, civil wars, acts of terrorism and similar events. Furthermore, I will only discuss the stock markets here, and not the many different asset classes that feel the impact of a geopolitical event. Evidence-based investors should use this note as guidance during the hectic and often irrational market phase following a flare-up of geopolitical tensions to separate the signal from the noise.

The most important rule for investors to follow in response to a geopolitical crisis is not to panic. The evidence is extremely clear on one thing: the vast majority of geopolitical events do not matter for stock market performance over an investment horizon of one month or longer.

So repeat after me: don’t panic. And resist the urge to sell stocks in a hurry. On average, the right response to a geopolitical crisis is to buy risky assets as soon as they sell out.

The knee-jerk reaction of investors to geopolitical crises is to extrapolate the latest events into the future and expect an escalation of a new conflict. This is the time when geopolitical experts appear on TV and in the press with their predictions about World War III or a Oil shock and stagflation in the style of the 1970setc.

Ignore these warnings and dire predictions, as in most cases they are based on the assumption that the crisis is rapidly escalating and spiraling out of control. However, that rarely happens. In the last 150 years we have seen only two cases where wars spiraled out of control. They are called the First and Second World Wars.

But we have seen hundreds of cases where a war broke out that could potentially trigger World War III, but did not. Think of the Korean War and the Vietnam War, the Cuban missile crisis, the many wars in the Middle East or the ongoing tensions between nuclear-armed North Korea and its neighbors. Think of the many civil uprisings during the Arab Spring of 2011. Yet things rarely get out of hand, because people like to live in peaceful times and will do their best to avoid war. It requires a staggering miscalculation both parties to escalate a war.

Hopefully you’ve managed to lower your heart rate and blood pressure while reading these lines (remember: don’t panic). Now it’s time to analyze the situation and act accordingly.

Question 1: Is the infrastructure of the country you are investing in damaged or destroyed (are ports or railways out of service, is the communications network damaged, etc.?)

If nocontinue with the next question.

If sothis is bad news for the local economy. It will likely mean a significant deterioration in GDP growth and therefore profit growth for affected companies. The companies managing the damaged infrastructure will sell out and it will take a long time to make up for these losses. But don’t forget the insurers and reinsurers who have to pay for the insured damage (unless there is force majeure, which is not always possible). On the other hand, there are opportunities for companies that repair and rebuild damaged infrastructure, such as construction companies, telecom and technology hardware, etc. Overall, however, it pays to move into defensive sectors such as healthcare and consumer staples, which have more resilient earnings growth in an economic slowdown.

Question 2: Is there a persistent impact (i.e. more than a year) on inflation and inflation expectations (for example, there is a significant disruption to global oil and gas supplies or a country spends large amounts of money to finance a major war)?

If nocontinue with the next question.

If soinvest in companies that benefit from higher inflation or that produce things that are in high demand. This means oil and gas companies in the event of an oil shock or defense companies in the event of increased government spending on war efforts, etc. Gold miners can also benefit indirectly from these developments. In the meantime, avoid companies with low profit margins and high sensitivity to input cost pressures, such as consumer goods and most industrial products. Favor companies with lower financial leverage and stable profits that can better cope with possible interest rate hikes by central banks or cuts in investment and consumer spending in response to higher inflation. Examples include the pharmaceutical industry, utilities (particularly regulated utilities), tobacco or essential consumer services such as communications services.

More generally, inflation rates used in a discounted cash flow model should be higher, while profit growth expectations should be lower because profit margins are compressed due to higher input costs.

Remark: Stocks are often sold as “real assets” that provide inflation protection as profits adjust to higher input costs. This is not true for inflation rates above c. 4% because companies are then generally unable to pass on higher input costs to end customers quickly enough and are faced with lower profit margins and a decline in profit growth.

Question 3: Is there a persistent (i.e. more than one year) effect on real interest rates (for example, because central banks raise or lower government interest rates through financial repression to keep interest costs artificially low)?

If nocontinue with the next question.

If soyou face a permanent increase in capital costs and a slowdown in demand, as higher financing costs have a significant impact on investment activity and consumer demand. This means that large parts of the stock market are heading south and a bear market is likely. If governments impose financial repression, it will be extremely bad for the banks and possibly also for the insurance companies. But if central banks raise interest rates, it will be good for banks and insurance companies as their profit margins will increase in the short term.

The name of the game is to get defensive, but be vigilant in avoiding highly leveraged companies that need to be refinanced in the next one to three years. Ironically, this can often mean avoiding classic defensive companies such as pharmaceutical companies or utilities, as these companies often have a lot of debt and high financial leverage. However, matters must be looked at on a company-by-company basis.

More generally, real interest rates used in a discounted cash flow model should be higher, while earnings growth expectations should be lower because profit margins are compressed due to higher costs of capital.

Question 4: Did you answer ‘no’ to all of the previous three questions?

If nowhat are you doing here? Go back to the questions above and start again.

If sobuy risky assets! The geopolitical shock has no permanent impact on inflation, real interest rates or profits, but instead only increases the risk premium on equities. Such spikes in risk aversion typically last a few days to a few weeks, so investors should use the headwinds in risky assets to invest as much as they can justify.

Note that the initial setback after the September 11 terrorist attacks lasted three weeks, and after the London bombings it lasted one day. The first setback after the Russian invasion of Ukraine lasted ten days, after which all losses were recovered. Only after this initial knee-jerk reaction did markets price in the expectation of a permanent rise in inflation and start falling again.

To reiterate the key finding of studies on geopolitical risks and their impact on stock markets: your default response should be to buy risky assets when they are temporarily sold out.

Only if there is a lasting impact on inflation, profits or real interest rates can one justify selling certain shares. But a lasting impact must be lasting. Stock prices may react to expectations for the coming quarter, but that’s just noise. Expectations would have to change for well over a year to have a significant and lasting impact on stock prices.

As Ben Graham already knew:

When investors vote with their feet, it is time for the superior investor to weigh the evidence and act accordingly.