I recently finished reading “Wealth, War and Wisdom” by Barton Biggs (Amazon link: here). This book looks at how various stock markets (US, UK, Germany, France, Japan and others) reacted to the events surrounding World War Two. This book is a must read for any stock market nerd – a perfect blend of general history and stock market history. I want to share with you one key takeaway from the book.
Before I show you a chart, let’s take a look at some of the major headlines for the UK stock market during World War Two:
- September 1939 – UK declares war on Germany
- June 1940 – France surrenders – Hitler tours Paris
- September 1940 – “The London Blitz” begins – massive bombing of London
- June 1941 – Germany attacks Russia
- December 1941 – Pearl Harbor – Japan draws the US into war
- June 1944 – D-Day – Invasion of Normandy
- May and September 1945 – Germany and Japan surrender
Now think about when the UK stock market* found its lowest price (the bottom) for the entire course of the war. The market bottom coincided with one of these headlines – pick the headline you think marked the “bottom” of the selloff.
The answer was June 1940: France Surrenders and Hitler tours Paris. The chart above is of the UK stock index in 1940 with important headlines overlaid. When I first saw this chart, I was shocked. The UK stock market bottomed the same month France surrendered?! The UK stock market rallied 30% up to the London Blitz, then kept going higher while London was being bombed daily?!
I will not show the chart of 1941, but after some selling to start the year the UK stock index rallied even further (while Germany won many battles and took Greece, Minsk and Kiev) and ultimately recovered ALL of the selloff that you see here in 1940. The UK stock market would never see the 1940 lows again**! It blows my mind to even write this. It would be four more years before US and UK troops set foot in Europe to even attempt to push the Germans back. It would be five more years before the war would actually end. How can this be?
- Markets price in bad news quickly. We saw this during Covid as well. Stocks sold off rapidly in March as Covid was just getting started. Then, as Covid cases and deaths rose throughout the year, stocks bottomed in late March of 2020 and never looked back. The same applies here. In June of 1940, UK stocks were pricing in a good chance that the UK would LOSE the war. When the UK held its ground and continued to fight into 1940, stocks started to “price-out” the UK losing the war which meant their stock market rallied. The author argues (and I agree) that the “worse” the war got, the odds that the US would enter the war alongside of the UK increased which therefore increased the odds of the UK winning the war.
- Markets are always looking for “fair value” but they often over-shoot and under-shoot that mark. This is what makes markets. This is why we have booms and busts. Markets swing from massive pessimism to massive optimism and back again – passing “fair value” along the way. If you are a buy-and-hold investor, its good to have an idea of where your investments stand when compared to fair value. But you also have to understand and be comfortable with the fact that those investments will trade on either side of fair value more often than not.
- Good investors are looking for OPPORTUNITIES during times like the 1940 chart of the UK stock market***. This is an extreme example but this is how markets work and this is how markets bottom. The worst-case scenario gets priced into markets via stocks selling off (or whatever market: commodities, bonds, etc.), and when that scenario does not play out, the market rallies. You see less severe examples of this all the time if you are paying attention. December 2018 comes to mind along with the Covid crash – as well as the last two presidential elections. Instead of panicking (as many do) during times like these, try to think of the situation differently. Has a particular asset class been hit so hard that it might be trading below fair value? Are many or all of the negative outcomes already priced into that particular market? If so, what opportunities are there to make money if those negative scenarios do not play out?
What this book has reiterated for me is: don’t be so sure that markets have to go down because the news is bad. Also, don’t be so sure that a market will go down if the news gets worse. The UK stock market in 1940 reminds us that markets often do the opposite of what you expect them to do.
Charles Brown is a CERTIFIED FIANNCIAL PLANNER™ and Financial Advisor at M. Brown Financial Advisors in Naperville, Illinois.
* Represented by the UK Financial Times 30 Industrials – this is an index – you can not invest directly in an index
**For the record, the US stock market bottomed in the 2nd quarter of 1941 – just after the battle of Midway.
***I know that there is a large amount of hindsight bias here because WE KNOW the US and the UK win the war, so its easy to say “buy the dip” when looking at this chart (German investors were not so lucky if they bought German companies in the mid-1940’s). So keep that in mind.
****The above article is informational in nature only and is not a recommendation to buy or sell securities. All information is gathered from sources believed to be reliable, but neither Charles Brown nor Ausdal Financial Partners, Inc guarantees the accuracy of the information. All investments carry a degree of risk. Individuals should consult with their tax and investment professionals before making changes to their investment portfolios.
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