War-Torn Bonds May Need Recession to Recover, Says Analyst Mike Dolan
Investors seeking safety from the Iran conflict have encountered unexpected risks, as traditional safe havens like government bonds and gold have failed to protect portfolios. Gold, which had already doubled last year, experienced its worst month in 43 years, while bonds have struggled to recover since the Ukraine invasion. According to financial analyst Mike Dolan, bonds may require an outright recession to perform effectively again.
Failure of Safe Havens in Conflict
Since the initial attacks on February 28, 2024, two key trends have emerged: energy prices have surged significantly, and neither bonds nor gold have provided the expected haven. Gold, often viewed as a hedge against inflation and global stress, has proven ineffective, likely due to its parabolic rise last year that already priced in risks before speculative frenzy took over. Now, it is being sold to meet liquidity needs.
Government bonds, a cornerstone of conservative fixed-income funds and mixed-asset portfolios, typically act as ballast during stock market downturns. However, in this conflict, they have not attracted the usual flight from risky assets. The prospect of oil-fueled inflation and hawkish central bank tightening has overwhelmed bonds, pushing yields higher to compensate for rising base rates and inflation expectations.
Historical Analysis of Bonds During Wars
A recent paper published on the Centre for Economic Policy Research's VoxEU site analyzed 300 years of government spending shocks, including major wars and the COVID-19 pandemic. It found that government bonds repeatedly generated substantial real losses during these episodes, underperforming equities and real estate. Over three centuries, wars have triggered large increases in U.S. and British government spending, averaging about 7% of GDP annually in the first four years, often not met by higher taxation alone.
The paper concluded that "wars are always disaster times for bondholders," with average real losses of 14% during the first four years of crisis. Cumulative returns were approximately 20% below stocks or real estate. In contrast, bonds tend to outperform during recessions and financial crises. Nominal returns during war periods were positive, but inflation erodes real value, as governments historically inflate their way out of war debt.
Current Market Impact and Future Outlook
Many investors hope the Iran conflict will be short-lived, but modern wars like the ongoing Ukraine conflict, now in its fifth year, suggest prolonged uncertainty. Government bonds are already recording losses, with exchange-traded funds tracking Treasuries and the Bloomberg Multiverse global government bond index down 2% in March. Neither index has recovered from the inflation and interest rate shock following Russia's invasion of Ukraine in 2022, remaining down 14% over five years.
Central bank rates have settled higher than pre-pandemic levels, and another sustained inflation burst could push them back up. In America, the fact that the inflation and rate shock four years ago did not trigger a recession is significant, as higher inflation and Fed rates prolong pain for bondholders. The key question now is whether bonds need a recession to truly outperform again, as central banks would likely lower rates in response to collapsing demand.
An energy squeeze and cost-of-living shock may eventually lead to a recession, but war alone does not boost bonds. Instead, it exacerbates losses, highlighting the need for diversified investment strategies in volatile times.
