It is hard to argue against the idea that geopolitical tensions are rising, and this type of backdrop can be incredibly difficult to navigate for investors. When the news is filled with discussions of war and conflict, it is natural to lose sight of our long-term investment objectives, and instead become focused on short-term, financial market worries. Yet, contrary to how these environments are likely to make us feel, a 2024 study showed that future equity market returns tend to be higher when coverage of war is more prominent in the media.

In a paper titled: “War Discourse and Disaster Premium: 160 Years of Evidence from the Stock Market“, a group of academics analysed 7 million New York Times articles spanning nearly 160 years and identified how much coverage was dedicated to a set of specific topics each month. They then linked the strength of this coverage to subsequent equity market returns from periods of one month to 36 months.

They found that of the topics considered, ‘war’ was the strongest predictor. Between 1871 and 2019, a 1 standard deviation increase in the intensity of war coverage in the New York Times predicts a 3.8% increase in annualised monthly returns. Over three years, the same rise in war coverage predicts 2.3% higher returns over the next 36 months.

In simple terms, the more that war was a focus of the articles in the New York Times, the higher subsequent returns were all the way up to three years out.

Why might war be good for equity market returns?

Although these results run counter to our behavioural instincts – not many of us treat war or rising geopolitical risk as a buy signal – that is probably the exact reason why this relationship appears to exist. For me, there are two plausible explanations for the phenomenon described in the paper:

• Heightened coverage of war and geopolitical risk leads investors to overstate the potential impact on financial markets and unduly mark down equity prices. This leads to lower valuations and higher future returns.
  
• Increased war coverage is an indicator of rising risk of economic and market catastrophe (what we might call disaster risk) and therefore equities are prudently priced lower. The expected return is greater because risks are also now more pronounced.

We can think of these explanations as being irrational (in the first case) and rational (in the second case). The consequences of both are the same – higher expected returns because equity markets have sold off and valuations are lower. In truth, both factors are probably at play.

Does geopolitical risk create buying opportunities?

Not so fast. There are some significant limitations with the study.

The first is the spectre of survivorship bias. While the data may show that future equity market returns rise alongside war coverage because investors overstate the risk of economic disaster, this is only true because there has been no such catastrophe. The world has to survive for us to see the results – so we cannot easily tell whether a pricing anomaly actually exists.

Equity market returns are predicted to be higher following periods of increased war coverage, provided the world doesn’t end!

(It may be reasonable to argue that if the world does end, we won’t be that worried about the returns from our equity portfolio).

The paper also does not advocate investing in specific countries that are the focus of increased geopolitical risks. It deliberately looks at general coverage of war and its impact on US equity markets. If instead it observed the impact on equity market returns of a country directly involved in a conflict, the results might be somewhat different.

Don’t compound geopolitical risks

The authors refer to the results of their study as a ‘war return premium’, which suggests it is something to exploit and potentially benefit from. However, I would frame the findings somewhat differently. When risks are prominent and emotive, we are liable to allow them to overwhelm our judgement, and prone to overstate the likelihood of worst case scenarios. We should guard against this.

If a ‘war return premium’ exists, it does so because of how investors react to the increased intensity of war coverage in the media. I think we should be less concerned about collecting the premium and more focused on not being the investor who pays it by making poor decisions in stressed geopolitical environments. The evidence suggests that our instincts during such times are likely to serve us poorly.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

All opinions are my own, not that of my employer or anybody else. I am often wrong, and my future self will disagree with my present self at some point. Not investment advice.