“Buy to the sound of cannons, sell to the sound of trumpets.”

-Lord Nathan Rothschild, 1810

The Rothschilds were one of the world’s richest families and went on to form a financial dynasty. In 1815, they were rumored to have made a fortune when they used a carrier pigeon to send the result of the Battle of Waterloo (which was “a damn close-run thing the nearest run-thing you ever saw in your life” according to the victorious general, the Duke of Wellington) from Belgium to London. Having the news before his rivals gave Nathan an edge over his competitors on the floor of the Stock Exchange.

This is a good story. It isn’t true, but it is a good story. It is true that the Rothschilds were known to use pigeons to communicate (an 18th century version of high frequency trading), and stressed the importance of timely information, but in this case, the messenger was a human who got the result from a Dutch newspaper and then took the boat to England. Lord Rothschild got the news, sold bonds to create a panic, then scooped them up as other traders saw this as a sign that the British had lost the battle. This true story seems just as good as the apocryphal one.

Given that he was a legendary (literally when it comes to the pigeon story) trader, it is hard to argue with Lord Nathan’s quote that I give above. The idea behind the phrase is that during times of war, investors panic and sell their stocks. This selling lowers prices to the point where they are a bargain. In contrast, when the war ends, people start to buy as their perceived risk is reduced. This increase in buying causes stock prices to rise, making this an attractive time to sell. This idea is really just a special case of being a contrarian – buying on the bad news and selling on the good news because in both instances, the market overreacts.

This all sounds good in theory. But is it actually true? It may have been the case during the Napoleonic Wars (or perhaps Rothschild was trying to fool us) but we shouldn’t take he idea on faith. We can test it. And by testing it, we are forced to be specific in what we mean. How do we define when the war starts? How long after do we wait to buy stocks? How long after the war ends do we sell them? Does it matter who is in the war? Does it matter where it is? Does it matter who wins?

Clearly every situation is different. For example, at the start of World War One, from July 31st to December 12th, the New York Stock Exchange was closed after a large number of foreign investors started selling assets to raise money for the war and for general security. Even though America did not enter the war until 1917, the huge level of uncertainty caused the Dow Jones Industrials to drop by 24% when trading resumed, its largest decline at the time. The London Exchange reopened at the start of 1915, although 1,600 traders and exchange employees had already enlisted in the new formed Exchange Battalion of Royal Fusiliers.

However, the start of World War Two was handled very differently. The London Exchange was closed for only six days in 1939, and for one more day in 1945 when the building was hit by a V2 rocket. Trading resumed the next day in the basement. The New York Stock Exchange didn’t close at all.

But it is pointless to focus on the specifics of each conflict before we know about the commonalities. That should give us a starting point when we think about how to position ourselves. Further, when the news channels get hold of a story, the specifics will dominate the coverage. We need to have a high-level view first.

It is easy to look back at the U.S. involvement in the major conflicts of the 20th century and see how the Dow reacted over the next year. This is summarized in Table One.

Table one: The Dow’s performance in the year after the US entry into the conflict (all information is for illustrative purposes only.)

This seems to support the bullish case, albeit in a very small sample. But each of these conflicts lasted a different time, so a year is not the holding period that corresponds to “selling to the sound of trumpets”. But redoing this simple analysis to correspond to the end of the US involvement is also straightforward. These results are shown in Table Two.

Table Two: The Dow’s performance during the period of US involvement (all information is for illustrative purposes only.)

Again, these results look slightly promising. But does it make sense to just look at the date when the US became involved. In the cases of the World Wars and Vietnam, the conflicts considerably pre-dated American involvement.

It would be good to have a more comprehensive study. Luckily, two New Zealand based academics, Henk Berkman and Ben Jacobsen, have studied the effects of war and other international crises on stock market returns (“War, Peace and Stock Markets”, an EFA 2006 Zurich Meeting working paper. Available at https://ssrn.com/abstract=885980).

They looked at a database that contained 440 international crises between 1918 and 2002. These events reduced stock returns by approximately 4% per annum. Most of these negative returns occur in the first month after the beginning of the war, but subsequent periods during the crisis also have below average returns. There is only a partial recovery when peace returns. Volatility also increases (by around a third) during crises. These effects are global but affect the countries directly involved the most.

Below is an overall summary of their results.

World Market Index

Average Annual Return: 3.96%

First Month of War (annualized): -5.23%

During War (annualized): -1.69%

First Month after War (annualized): 3.2%

(All but the last of these numbers is statistically significant at the 5% level.)

Some incidents have worse effects than others. When the crisis begins with abrupt violence or when major world powers are in direct conflict, the negative effects are larger. However, I would caution traders about deciding whether an incident is “major” or not. There is a very good chance that by the time an incident comes to the attention of the general public, it would be major. For example, in March 2014, the Ukrainian/Russian conflict was clearly major, but how would one classify the Papuan dispute which has been ongoing since 1963 and has over 400,000 casualties but only 33 in 2023? Sadly, there are wars going on all the time and most of them escape our attention.

The broad conclusion a trader should draw from this extensive and careful study is that wars are bad for markets and increase volatility. I’m not a Rothschild, so I have no doubt that some people will choose to believe him instead of me. But you don’t need to believe me, believe the numbers.

I won’t criticize the trading skills of a Rothschild, but it seems that what he said is no longer true, if it ever was (I have a fairly good idea that he may have known that all along…)

Instead, we should probably listen to one of the most famous strategists of all time.

“There is no instance of a nation benefitting from prolonged warfare.”

-Sun Tzu in “The Art of War”