“At heart, uncertainty and investing are synonyms.” –The Intelligent Investor, Benjamin Graham (1949)

In writing this post, we thought about how privileged we are to worry about the war in Ukraine primarily through the lens of investing, rather than being in a position where we ourselves are fleeing an invading army. Our blog has a global audience, and we know that we have readers in Ukraine, other Eastern European countries, and Russia. Today, there are wars going on in countries other than Ukraine as well. The human suffering of these wars is of equal moral importance. War in any country is a tragedy for all of humanity.

But this is an investing blog, and so in this post we will focus on the issues where we think we can offer useful insights and perspectives, even while we keep in mind the much larger human tragedy that is playing out in Ukraine.

In our post yesterday, we described the potential economic impact of the war in Ukraine and we argued that it was the economic impact of war that drives the stock market, more so than the violence itself. In this piece, we share the data showing that war that does not occur on US soil has rarely impacted the stock market by all that much. The main exception was WWII and even then, it took full blown global warfare and the near complete destruction of much of Europe, for the US stock market to decline significantly.

The chart below illustrates how geopolitical events have impacted the market in the past. The Cuban Missile Crisis may be one of the most relevant examples on this list, since it was a confrontation with Russia and at the time there was significant and well-informed worries of an attack, possibly a nuclear attack, on US soil.

(Source: Vanguard)

With 9/11, we can see a more recent example and one that involved an attack on US soil and triggered widespread fears of more such attacks on US soil, even including things like a “dirty bomb” or other weapons of mass destruction. After falling by 12%, the stock market rallied back to new highs.

(Source: Bloomberg)

Incredibly, even the bombing of Pearl Harbor during WWII, which has been the only act of war on US soil since the Civil War (actually not technically, since Hawaii wasn’t a state at the time), only caused a 10% drop in the market before it fully rebounded.

(Source: Bloomberg)

But to be clear, we are not at all being dismissive of the threat of war. Our decisions in our investment strategy are not predicated on the idea that wars don’t impact the market. Rather, we think investors need to realize that war itself is not the major driver of market risk. It is the economic implications of war that matters, and this is what we wrote about yesterday.

Of course, expansive war on EU or US soil does matter to the US stock market. If there is widespread destruction of economic assets and the killing of workers, this would clearly have a huge negative impact on the stock market.

While it wasn’t on US soil, WWII of course involved exactly this type of widespread destruction across much of Europe. The US stock market fell by 32% from the start of WWII to the low point in 1942 and then rallied to new highs as the Allies won the war. Surprisingly to many investors, the market actually rallied initially, and if measured from the high to the low, the decline in the US stock market during that time was a bit more than 50%.

(Source: Bloomberg)

But the Allies won the war. Germany lost WWII and here’s what happened to their stock market.

(Source: Wealth, War and Wisdom, Barton Biggs)

If European or US economic assets are destroyed as part of a large-scale military conflict, there is no doubt that would be a terrible outcome for humanity and for the stock market. This outcome is already real in Ukraine, and the human and economic tragedy there is enormous.

But as much as this risk playing out in the US or EU cannot be dismissed, it is important to note that even then stock markets have recovered to new highs over time. The exception, as seen in the chart of the German stock market during WWII, is when the country in question loses the war and sees its country effectively come to an end.

So, it is important to recognize that our thinking on managing stocks during the current crisis does assume that the US, and to a lesser degree the EU, will not experience widespread destruction of their economic assets and eventually lose the war, bringing about the end of US history. But this is a “bet” we are willing to make. There are some risks in investing that simply cannot be hedged.

As we continue to process incoming news flow, we will focus on the economic impact of the war. This includes the impact of any potential direct military engagement between Russia and NATO. We are in no way dismissive of the potential economic risks. In our recent post on the economic impact, we made clear that there is risk of both a recession and high inflation occurring at the same time. While we believe that the market is overreacting to this risk currently, and we believe our portfolio holdings are positioned to better navigate this sort of stagflationary economy than the average company, we will constantly recalibrate our point of view as more data and evidence becomes available.

If we come to the conclusion at any time that we should trim or sell stocks in our portfolio because of the way the economic impact of the war has evolved, we will take such action immediately.

Over our 18-year track record, we’ve owned stocks during an unprecedented global housing crash, periods of very rapid energy price increases, all sorts of global debt defaults, an ultra-contentious US political environment, a trade war with China, a global pandemic, etc. We can’t say that we foresaw all of these events in advance and during those events we never made huge changes to our portfolio. But over that time period we successfully navigated the challenges at hand.

The way we have navigated all the uncertainty and unexpected events over the last two decades was not by trying to predict the future and make big changes to our portfolio based on various predications. Instead, we assembled a portfolio of companies that we thought were well positioned to navigate uncertainty. And in retrospect, that’s what these companies were able to do. Not every one of them of course, but in the aggregate, our portfolio holdings managed their way through these events and did so better than the average company.

One thing that is useful about the fact that we publish our investment thinking in real time, is you can go back to look at how we handled past periods of high uncertainty. You can read here what we wrote during the US-China trade war, as recession worries swirled. And you can read here and here what we said at the very beginning of COVID.

So, in thinking about how we should react to the risk of war, much of our answer has to do with the strategy we were employing even prior to the war in Ukraine. We knew unexpected things would happen, even if we didn’t know what would happen or when, so we assembled a portfolio of highly resilient, robust businesses. Once doing that, we closely monitor them and update our assessment of their robustness and the value of each stock constantly.

We don’t just buy and hold stocks, we buy, hold, and constantly refresh our analysis. We wrote this post last year saying that “there is no such thing as buy and hold” and we think helps explain how and why we constantly reevaluate our thinking on every stock in our portfolio during periods of both high and low perceived uncertainty.

We say “perceived uncertainty” because in fact the future is always, at all times, uncertain. In our post during the US-China trade war, we wrote:

“Investors hate uncertainty. You hear it almost every day on CNBC. Some pundit saying a version of “we are cautious due to the high level of uncertainty.” Looking back on my own investment career, I recall no time period in which pundits on CNBC proclaimed their bullishness due to the high level of certainty. There is no certainty in investing, only making the best possible decisions based on the information you have at hand.”

Our team is monitoring global events very carefully and will make any changes in our portfolio that we think will offer better risk adjusted returns over the long term.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

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