Increasing chaos and unpredictability, especially in the initial phase of the conflict, cause fear, which is reflected in market outcomes (volatility) and encourages capital withdrawal (changes in allocation).
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Pre-war uncertainty promotes a greater sense of perceived risk than the war itself and the threat when it becomes a reality. Rising geopolitical uncertainty in the stock market directly increases risk premiums and encourages sudden adjustments in investors’ positions.
Research reveals that financial market returns are directly dependent on investors’ fear levels. Anxiety and caution in the markets suppress profitability, while confidence increases it.
The level of fear in finance is measured by special instruments. The main ones are: the market volatility VIX index and the Fear and Greed index.
In the initial stage of the conflict, a reaction is often observed in the broad market where risk is avoided, leading to a short-term sell-off. To avoid potential losses, investors sell riskier assets. Later, after the initial shock subsides, stock prices recover. The market focuses on the future and quickly adapts.
The average one-day market reaction to historical geopolitical crises – including wars and terrorist attacks – at the start of such an event is about -1%.
The market reaction is determined not by the conflict itself, but by its economic consequences and possible impact on the country’s or the world’s economy.
The market recovers after 28 days
Significant geopolitical events often do not have a long-term negative impact on stocks and broad market indices. This is confirmed by decades of stock market data.
Based on an analysis of geopolitical events since World War II, after 73% of armed conflicts that occurred post-World War II, stock market results were positive one year after the act of aggression.
After 73% of armed conflicts that occurred post-World War II, stock market results were positive one year after the act of aggression.
Analyzing the 20 largest military conflicts, it was found that the “S&P 500” index fell on average by 6% from the start of the shock. In 19 of these 20 cases, the market took on average just 28 days to return to the pre-event level. This happened despite some interventions lasting very long – years or even decades. In other words, historically, the duration of a specific conflict had almost no impact on market dynamics.
One of the most recent examples illustrating long-term market resilience during periods of uncertainty is the “S&P 500” index, which immediately after the Russian invasion of Ukraine on February 24, 2022, dropped more than 7%, but recovered within a month and rose above the level recorded before the military invasion began.
During periods of geopolitical tension, large-cap market portfolios have an advantage over small and mid-cap portfolios. Large-cap company markets and globally diversified indices of such companies (e.g., “S&P 500” and “MSCI World”) recover faster after geopolitical shocks – this is due to the diversification of international companies’ operations and revenue sources and their financial flexibility (available financial reserves).
Meanwhile, local markets or markets of smaller capitalization companies face concentrated economic damage, long-term capital outflows, and regional supply chain disruptions. Historically, large-cap company stocks generated positive excess returns (adjusted for risk) during periods of high market volatility, while small-cap stocks often poorly protect against value decline. During periods of uncertainty, investors worldwide often prefer large companies.
Although direct military conflict causes instability and large fluctuations in financial markets, the resulting uncertainty shapes market dynamics and often creates a kind of “fragile resilience”: the stock market rises despite geopolitical risk and increasing vulnerability. The market quickly assesses the scenario of a real economic downturn, focusing mainly on long-term corporate profit indicators, monetary policy, and structural growth factors.
Not only wars have an impact
Military conflicts are not the only events affecting the broad stock market – the broader macroeconomic environment is equally important. During such periods, the market becomes volatile, and stock sell-offs occur as a reaction to risk reduction.
For example, the 2008 financial crisis caused a stock market decline during the war in Afghanistan (2001–2021), but this decline was not related to the military actions themselves.
In February 2020, as markets began to perceive the possible impact of COVID-19 on the global economy, the “S&P 500” index fell nearly 30% in a month, with daily price fluctuations ranging from -10% to +7%. These fluctuations reflected great uncertainty about the duration and scale of the pandemic.
Another example – US President D. Trump, who on April 2, 2025 – a date he called “Liberation Day” – announced a huge import tariff package on goods applied to many countries and punitive tariffs on several countries.
After these announcements, on April 3 and 4, US stock indices fell sharply: “Dow Jones” – 9.25%, “S&P 500” – 10.8%, and “NASDAQ” – 5.8%. On April 9, in response to ongoing financial instability, President D. Trump announced a 90-day moratorium on most tariffs (except those applied to China). This announcement led to a sharp rise in stock markets: “Dow Jones” rose 7.87%, “S&P 500” – 9.52%, and “NASDAQ Composite” – 12.16%.
Growing interest in the defense industry
Although geopolitical shocks cause short-term uncertainty, long-term market dynamics remain unchanged. Investors cannot control global events but can manage risk levels and diversification (asset allocation).
In an economy operating in a “war fog,” where active military conflict causes high geopolitical uncertainty in the market, leading to price volatility and supply chain disruptions, with unclear war duration, investors choose safe investments such as precious metals, e.g., gold.
Defense sector stocks are another risk mitigation tool – a kind of “safe haven,” a hedge against geopolitical risk. These stocks are considered safe sector stocks.
Production of military equipment – for example, aircraft, warships, or missile defense systems – takes several years. Companies work with huge order packages that guarantee stable income for a long time even after the conflict ends. Defense sector stocks, like gold, have been in high demand in recent years and have outperformed general market indices.
During periods of high geopolitical tension and regional conflict escalation, defense sector stocks often behave contrary to the broad market – prices of large US and European defense contractors’ stocks rise, often statistically significantly exceeding average stock market returns. In other words, worsening geopolitical situations open greater opportunities for investors. This advantage is driven by expectations related to increasing military state expenditures and sustainable revenues during and after the conflict.
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Geopolitical tension and strengthening military power can directly benefit the defense sector, as conflicts rapidly increase demand for weapons and ammunition. Rapidly depleted military stocks force governments to urgently place new orders with factories. This not only helps replenish reserves and consumed stocks but also encourages long-term investments and urgent expansion of production capacities, hoping for larger defense budgets. Usually, the industry plans these capacities in advance, even before conflicts begin, thus shaping the demand for modern weapons and ammunition.
Long-term contracts ensure stable income, which supports stock value. However, price corrections are possible in the sector if stocks become too expensive. Higher value and high price-to-earnings (P/E) ratios limit future growth.
After military conflicts subside, stocks of this sector decline
An analysis of 75 defense companies worldwide, mainly from Europe, the US, and South Korea, revealed that geopolitical events significantly affect the returns of this sector’s stocks. The impact is not uniform. It depends on the event’s duration, scale, and how the market assesses future threats.
After conflicts end and defense budgets return to normal levels, defense industry companies’ stocks often decline.
Just as defense sector stocks usually experience a correction or stabilization phase after a sudden surge, price corrections or a transition to a consolidation phase occur after active conflicts subside, threats decrease, and military budgets stabilize. Stock prices fluctuate horizontally within a narrow range (corridor) because long-term growth potential is already priced in, leaving little room for rapid further increases in P/E ratios.
During the consolidation phase of defense sector stocks, the market shifts from a speculative growth period, often driven by a sudden increase in geopolitical tension or budget spending announcements, to a stage where the main focus is on achieving planned goals. The most important factor becomes individual companies’ ability to efficiently execute existing multi-year orders and maintain profitability (profit margins). Profitability can be negatively affected by rising supply chain costs, labor shortages, and fixed-price contracts.
What are the alternatives?
As growth in defense sector stock markets slows, investors may rotate capital between sectors seeking higher growth or better yields.
During rapid and synchronous economic growth, capital is usually directed to cyclical sectors – raw materials and energy. Favorable interest rates encourage funds to be redirected to high-volatility and market-sensitive technology, artificial intelligence, and software companies, whose beta coefficient exceeds 1.5.
Financial regulators, such as the European Central Bank (ECB), warn of possible asset value corrections related to the popularity of investments in this theme. Another alternative to defense stocks is the more stable sectors of essential consumer goods, healthcare, and utilities. These sectors are characterized by non-cyclical, inelastic demand. They usually have low beta values and smaller price fluctuations during market corrections.
An alternative to the defense sector is other defensive stocks: essential consumer goods, healthcare, and utilities sectors. These areas are characterized by non-cyclical, inelastic demand, low beta coefficients, and smaller price fluctuations during market corrections.
So, to summarize the stock market reaction to geopolitical tension in terms of price changes and investment returns.
Wars and interstate conflicts not only destabilize the geopolitical environment but also directly affect capital markets: disrupting trade flows, distorting the supply and demand balance of assets, and reducing investor confidence. Such structural changes transform the investment climate, change market participants’ behavior, and determine stock market dynamics.
The initial stock market reaction to geopolitical conflicts and wars is almost always negative, causing short-term uncertainty. Due to increasing risk fear, major stock indices fall sharply. Investors urgently withdraw from risky asset classes and choose safer alternatives.
Market declines caused by geopolitical crises are usually short-term. Long-term market trends are determined by corporate profitability and economic growth, not geopolitical news or conflicts. Geographic and sectoral portfolio diversification mitigates the negative impact of crises.
During periods of geopolitical tension and conflicts, defense sector stocks often outperform the general market. Sudden regional conflicts cause a direct speculative rise in stock prices due to increased purchase volumes – the “run to arms.”
The defense sector is resilient to economic cycles and often acts counter-cyclically. During economic downturns, the need for weapons does not decrease, and due to increased geopolitical tension and states’ priority on national security, it often even increases. Defense sector stocks are considered protective assets.
The most important factor for the value of defense sector stocks is state defense budgets. The size of the defense budget is primarily determined by geopolitical threats to national security, state security policy, and commitments in international alliances. After the 2022 Russian invasion of Ukraine, European and US defense companies’ stocks rose rapidly.
The defense industry is attractive to investors due to long-term, government-approved contracts that ensure guaranteed revenue streams. Due to this monopsonistic market specificity, the sector’s performance is highly predictable and reliable, so defense companies’ stocks are often classified as protective assets.
As growth in defense sector stocks slows, investors seeking higher returns move their capital to other sectors.
What is the broad stock market reaction to the current war in the Middle East?
In the first quarter of 2026, global stock markets experienced very volatile dynamics. Starting the period with positive prospects and optimism, markets later entered a correction and recorded a decline. The military conflict in the Middle East significantly disrupted global energy and logistics chains, threatened the world economy, and led to increased production costs.
However, global stock markets showed resilience during the US and Iran conflict. Despite shocks, due to ceasefires and the development of AI-related technology sectors – an area whose demand is essentially unrelated to the recent energy crisis – stock markets managed to recover. Although large fluctuations were initially recorded in stock markets, later price direction became positive, and major stock indices demonstrated growth. Investors’ confidence and positive expectations were fully justified by actual financial performance results.
And how did defense sector companies’ stocks react to the US and Israel conflict with Iran?
The initial response: a sharp stock price surge to historic highs. After the first weeks of the conflict, the rise in defense stocks lost momentum, and some companies’ capitalization began to decline. The conflict highlighted specific defense technology areas (subsectors) receiving the most investor attention.
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