The world is at war…
According to the United Nations, the world is currently experiencing the highest number of violent conflicts since 1945 – when World War II ended.
Two billion people – a quarter of the world’s population – now live in a conflict-affected area.
The conflicts include military-led coups, the threat of nuclear weapons, and the fight against terrorist networks.
As an investor, it’s challenging to prepare for this rise in conflict. But it’s imperative you ask yourself one question – is my portfolio too reliant on peace?
If you’ve only begun investing over the last 30 years, then it’s highly likely it is.
You see, in that time, the world has seen relatively less conflicts than its historical average.
That’s right, even with the war on terror and massive civil wars in Syria and across Africa, the period from 1990–2020 has seen less conflict deaths than the average since World War II.
While declining conflict casualties is a good thing… It means most investors today haven’t needed to consider the impact of global conflict on their portfolio.
But with the world now experiencing a surge in conflict, now is the time to position your portfolio for this new era.
In this essay, I’ll go over why your portfolio may not be suited to deal with global conflict.
I’ll also go over an asset class that needs to be in your portfolio to help it avoid being another casualty of war.
Conflicts Disrupt Supply Lines
The breakout of a global war typically results in a series of knock-on effects that can wreak havoc on a portfolio.
The first is a disrupted supply chain, particularly in the regions directly affected by the conflict. This often leads to shortages of essential goods and services.
At the same time, wars require vast amounts of resources, like raw materials, labor, and energy. This stimulates intense demand for basic necessities like food and water and crucial materials like metals and oil.
On top of that, governments often resort to printing money to help fund military operations – further stimulating demand.
A rise in demand with a hobbled supply chain causes prices to spike.
Historically, the U.S. rate of inflation has risen during periods of war.
|War||Date Prior to Conflict||Inflation Rate Prior to Conflict||Date of Peak Wartime Inflation||Peak inflation Rate||Percentage Point Increase in Inflation Rate|
|World War I||June 1914||1.0%||November 1918||20.7%||19.7|
|World War II||August 1939||-2.1%||May 1942||13.2%||15.3|
|Korean War||May 1950||-0.4%||February 1951||9.4%||9.8|
|Vietnam War||October 1955||0.4%||December 1974||12.3%||11.9|
|Gulf War||July 1990||4.8%||October 1990||6.3%||1.5|
|War on Terror||August 2001||2.7%||July 2008||5.6%||2.9|
As you can see in the table above, during times of global war, the U.S. inflation rate rose by an average of 10.2 percentage points to an average peak of 11.3%.
That’s well above the historical average inflation rate of 3% in between wars.
In this inflationary environment, the traditional 60% stocks/40% bonds portfolio that most investors follow isn’t ideal.
Since 1900, the 60/40 portfolio has averaged a 7% annualized return during major global wars, including both world wars, the Korean and Vietnam Wars, and the war on terror.
In periods without a major global war, the 60/40 portfolio has averaged a 10% annualized return.
Much of that underperformance is due to the lackluster returns from bonds.
According to the CFA Institute, over the past 100 years, long-term U.S. government bonds averaged a return of 5.6% a year. However, during times of global war, those same bonds only average a return of 2.2% a year – a 60% drop.
This is a direct result of the inflation and government borrowing that arises during periods of war.
Higher interest rates generally accompany higher inflation – this has a negative impact on a bond’s returns because bond prices move in the opposite direction of interest rates.
On top of that, governments borrow more money during times of war, which also drives up interest rates.
As a result, the conflicts can leave your bond portfolio vulnerable to below-average returns.
So if you’re sitting in a traditional 60/40 portfolio, you should take this as a sign to act now.
Any further escalation of global violence may cause your portfolio to underperform your expectations for years or even decades.
If you want to prepare your portfolio for war, you must make sure you have exposure to the following asset.
Commodity Prices Rise During Conflict
Throughout history, conflicts have directly correlated with increasing commodity prices.
Even before fighting begins, governments scramble to stockpile critical supplies needed in a prolonged war.
Then the outbreak of fighting weakens supply chains.
Rising demand for critical resources at a time when supply chains are weakened causes prices to soar.
This is exactly what happened in World War II. From the 1939 invasion of Poland to the attack on Pearl Harbor in 1941, a broad basket of major commodities rose by an average of 23%.
Certain commodities like food products and cotton led the way, rising by 35% over that period.
During the Vietnam War, demand surged for metals and industrial products to make weapons and military equipment. From 1960 to the war’s end in 1975, the price of iron doubled from $11 to $22 per metric ton.
We’re seeing the effect of war on commodity prices play out today with the war between Russia and Ukraine.
Both countries are key exporters of fertilizers and grains. The outbreak of the war caused prices of wheat and barley to rise by as much as 79% and 62%, respectively.
The outbreak of war also pressures the price of oil to rise.
The heavy use of weapons, tanks, and aircrafts causes demand for oil to spike. However, it’s supply issues that primarily drive its price higher.
We often see major oil-producing regions embroiled in fighting, which puts production at risk. At times, countries have used the price of oil as a de facto weapon.
We saw that in 1973, when Arab states instituted an oil embargo against countries supporting Israel during the Yom Kippur War. That caused oil to nearly triple from $25 to $66 a barrel in six months.
The outbreak of the Gulf War in 1990 caused the price of oil to double from $20 to $40 a barrel in three months.
Then there was the U.S.-led war on terror. The invasion of Iraq and subsequent conflict disrupted oil production and contributed to oil rising 167% from $30 to $80 a barrel from 2003 to 2006.
Another commodity that often rises during times of war is gold.
Gold is a safe-haven asset in the mind of many investors.
When war breaks out, investors often seek safety in gold as a store of value. Plus, it also acts as a hedge against the consequences of heavy government borrowing.
We saw a rush to gold most recently at the start of the Russia-Ukraine war when gold spiked 14% over two months.
How to Prep Your Portfolio for an Era of Conflict
Ensuring your portfolio has exposure to commodities is an effective way to protect it from the forces of war.
Even a 10% allocation to commodities can go a long way.
Over the last five years, the average 60/40 portfolio has averaged a 5.9% annualized return.
However, by taking 10% from bonds and allocating it to commodities, that annualized return would have been bumped up to 6.6%.
And a recent study by Vanguard found that for every 1% rise in inflation, commodities rise anywhere from 6% to 9%.
A great way to get exposure to a diversified basket of commodities is the iShares GSCI Commodity Dynamic Roll Strategy ETF (COMT).
This is a low-cost exchange-traded fund that covers everything from gold and oil to industrial metals and grains.
The fund also doesn’t require K-1 tax reporting, which means investors don’t have to deal with the annual tax headache that traditionally comes with commodity funds.
Another asset that can protect your portfolio from the breakout of global war is bitcoin.
Bitcoin is relatively young. It’s only been around since 2009. As a result, there is little history to turn to for how crypto would perform during a global conflict.
However, the Securities and Exchange Commission considers bitcoin a commodity. So we expect it to perform like other commodities during conflict.
For instance, a study by Morningstar concluded that a 5% allocation to bitcoin increases risk-adjusted returns by 25%.
The last time the dollar had a similar crisis like this was during the pandemic in 2020.
The world was on the brink of collapse from the authoritarian restrictions placed on citizens around the globe.
At the time, Daily editor Teeka Tiwari issued this warning to his readers:
Friends, with the near collapse of global trade caused by the coronavirus… You can expect central banks [to] issue stadium-sized stacks of paper money to fund their respective governments.
On March 17, 2020, bitcoin traded as low as $5,032.50. Just two days later, Jerome Powell and the Fed went about the greatest monetary policy mistake of the millennium.
By the second half of 2021, bitcoin would reach an all-time high of $69,044 – a 1,271% rise.
Some of the altcoins Teeka recommended at that time did even better. His readers had a chance to make 27 times… 56 times… and even 850 times their money – in less than two years.
Recently, Teeka put together a model portfolio of five cryptos – bitcoin and four altcoins – that he believes could potentially deliver the kinds of returns our readers had a chance to see when he made the same warning in 2020.
In times of war, when the value of fiat currencies is at risk due to massive government spending, crypto can help preserve your purchasing power.
So make sure to add some exposure to your portfolio before it’s too late.
Analyst, Palm Beach Daily