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 was ending.
Two billion people, a quarter of the world’s population, now live in a conflict zones. That includes the Russia-Ukraine war in Europe and Israel’s war against Hamas in the Middle East.
I know this is an uncomfortable topic for many of you. However, the heightened uncertainty that war brings can have far-reaching effects on your wealth.
As an investor, it’s challenging to prepare for 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 fewer 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 saw fewer conflict deaths than the average since World War II.
That 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 global conflict, now’s 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.
The Knock-On Effects of War
The breakout of a global war typically results in a series of knock-on effects that can wreak havoc on a portfolio.
A knock-on effect is simply an indirect consequence of a larger event or phenomenon. But they can be significant.
For example, conflict can disrupt supply chains. This often leads to shortages of essential goods and services like food and energy.
Meanwhile, wars also require vast amounts of resources, including raw materials, labor, and energy.
This stimulates intense demand for basic necessities like food and water and crucial materials like metals and oil – the same goods suffering from supply chain disruptions.
On top of that, governments generally crank up the money printer to help fund military operations – further stimulating demand.
For instance, the United States spent an estimated $176 billion on the Vietnam War (over $1 trillion in today’s dollars) and an estimated $2.3 trillion on the Afghanistan War.
Historically, these knock-on effects cause a spike in inflation.
During times of global war, the U.S. inflation rate has risen by an average of 10.2 percentage points. That’s an average peak of 11.3%.
That’s well above the historical average inflation rate of 3% in between wars.
Here’s what 11.3% inflation means for you…
Imagine the $1,800 you pay in monthly rent costing you an additional $200. Or your $400 monthly grocery bill costing you an additional $50. Or your weekly $80 charge to fill up your gas tank now costs $90.
More importantly for you as an investor, high inflation is a drag on stocks and bonds.
Rising prices of raw materials can make it more costly for companies to build their products, eating into their profits. Additionally, high inflation adds uncertainty to long-term planning, making it harder for companies to grow efficiently.
On top of that, high inflation tends to bring higher interest rates, which lowers the fair value of a company’s future earnings and lowers bond prices.
In this inflationary environment, the traditional 60% stocks/40% bonds portfolio won’t cut it.
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 of peace, the 60/40 portfolio has averaged a 10% annualized return.
Much of that underperformance is due to the poor performance of 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 conflict, those same bonds only average a return of 2.2% a year – a 60% drop.
So if you’re sitting in a traditional 60/40 portfolio, you should take this as a sign to act now.
This Asset Class Rises During Conflict
Throughout history, the outbreak of war has directly correlated with increasing commodity prices.
We saw that happen 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%.
During the Vietnam War, the price of iron doubled from $11 to $22 per metric ton.
During the 1973 Yom Kippur War, when Arab states imposed an oil embargo against Israel’s allies, oil nearly tripled from $25 to $66 a barrel in six months.
The outbreak of the Gulf War in 1990 caused oil prices to double from $20 to $40 per barrel in three months.
We’re seeing the same knock-on effects today from the Russia-Ukraine war.
Both countries are key exporters of grains. Since the outbreak of the war, wheat and barley prices have risen by as much as 79% and 62%, respectively.
Another commodity that often rises during times of war is gold.
When war breaks out, investors often seek safety in gold as a store of value. Plus, it also acts as a hedge against government borrowing to pay for war.
We saw a rush to gold most recently at the start of the Russia-Ukraine. Gold spiked 14% from February 2022 to March 2022.
The Best Way to Protect Your Portfolio From Global 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%.
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.
Now, bitcoin has only been around since 2009. So there’s little history on how it reacts to a global conflict.
But Daily editor Teeka Tiwari considers bitcoin “digital gold.”
Just like gold, bitcoin has a limited and finite supply. There will only ever be 21 million bitcoins minted. This creates scarcity and can help them retain their worth over the long term.
Plus, bitcoin has historically had a low correlation with traditional financial assets like stocks and bonds, meaning it has moved independently of them.
That has helped bitcoin become viewed as a store of value outside of the influence of traditional systems like governments and powerful banks, like gold has.
In times of war, when the value of fiat currencies is at risk due to massive government spending, bitcoin will serve as a hedge to preserve your purchasing power.
And if you’re looking for smaller cryptos with potentially higher upside than bitcoin, Daily editor Teeka Tiwari has found a project that’s enabling a major trend: the rollout of a central bank digital currency, or CBDC.
You see, the Federal Reserve recently launched a program that could lead to a mandatory recall on the U.S. dollar.
According to Teeka, this program could replace the dollar with a new digital version that will be radically different from what you have in your bank account right now.
He’s put together a briefing to explain what this new digital dollar regime means for you and your money.
You can watch it for free right here.
Regards,
Michael Gross
Analyst, Palm Beach Daily