Thread by @StuLoren

1/ This is a thread on my rationale underlying the #investment opportunity in #defense firms. A compelling #value opportunity in an otherwise mostly expensive market. Touches on the realities of human nature and the growing risk of global conflict.

2/ The history of man is largely a history of conflict. As advanced in technology and morals as we'd like to think we are, I tend to side with the Hobbesian view that the the natural state of the world is one of anarchy, or: "the condition of Warre."

gutenberg.org/files/3207/320…

3/ Governments serve many key functions and can take many forms - I'm partial to liberal (lowercase L) democracies - but historically all share a common purpose and source of legitimacy: to keep their citizenry safe. There can be no prosperity without security.

4/ I know respected and far more focused / informed academics like @sapinker may argue otherwise - that life is getting better. And I have read The Better Angels of Our Nature, and it is very good!

amazon.com/Better-Angels-…

5/ But I fear that the worldview espousing that human affairs are continuously improving - even though based on empirical data - may be becoming somewhat outdated.

6/ Many of us - and especially many policymakers - developed our international relations frameworks over the last 30 years following the fall of the Soviet Union, during which time the U.S. was the unequivocal superpower.

7/ But rather than an "end to history," as stipulated by the political scientist Francis Fukuyama, the last 30 years may be better categorized as a hiatus.

amazon.com/End-History-La…

8/ Now I'm just an amateur historian... but my view on conflict is that state vs state confrontations boil down to one of three broad causes:

1) Resources (conflicts over scarcity)
2) Religion (conflicts over ideology)
3) Retribution (conflicts to right perceived wrongs)

9/ When the U.S. acted with the authority of the world's chief power, these types of conflicts were mostly held in check. And yes, I know there were egregious and regional exceptions, which I'm not seeking to minimize. But we had nothing on the scale of wars like WW1/2.

10/ From Pax Romana (27 BC to 180 AD) to Pax Britannica (1814-1914), it's not unusual for large scale conflict to recede during times of unchallenged global hegemony.

11/ No need to rehash current events, but safe to say that the U.S.'s global leadership both militarily and economically is now in question. Not trying to make a bold prediction here, but Pax Americana may in retrospect turn out to be a relatively short-lived period.

12/ Now let's get back to the 3 causes of conflict and purpose of governments...

13/ #1: Resources: if you've paid attention to the news of late or prices (see Bloomberg Commodity Spot Index chart below), it's obvious we are in a state of key natural resource deficits. Conflicts over land, food, materials and energy sum up most of the history of war.

14/ #2: Religion: Wars over ideology don't occur with as much frequency, but I fear that social media has helped radicalize a huge chunk of the global population. It's a tinder waiting for a match. See more from Samuel Huntington's Clash of Civilizations.

amazon.com/Clash-Civiliza…

15/ #3 Retribution: This is perhaps the greatest near-term cause for concern. Russia feels aggrieved over territorial losses in Eastern Europe following the dissolution of the USSR. It is emboldened by Europe's reliance on it for gas. Was Crimea a preview of more to come?

16/ In China, the CCP believes Taiwan must be re-unified with the mainland. It is increasingly flying provocative incursions over Taiwanese airspace. In the sea, its navy is challenging the territorial integrity of Japan, the Philippines and Australia.

17/ Both Russia and China are more prone to act if they doubt a strong U.S. or allied response. Not going to summarize the last few years of news, but they unfortunately have reasons for their doubts.

18/ Again, the first purpose of government is to provide security. If Pax Americana is eroding and the world is reverting back to its Hobbesian natural state (more prone to conflict), then I think it follows that security is going to come back into sharper focus.

19/ Now for the investment implications. As I've highlighted in several recent threads, it's getting harder to find value in public markets. Conveniently for this topic, one segment with still attractive valuations are #defense firms.

20/ Global governments are likely to step up defense spending in the face of growing threats and doubts over U.S. security assurances. In large part, any government's legitimacy depends on the ability to keep its citizenry safe.

21/ I think it follows that defense spending will shift from a perceived medium priority category of discretionary spending to a high priority mandatory spend category, and a rising one at that.

22/ Not recommending specific stocks, but quality firms like $LMT, $RTX, $NOC, $GD, $LHX to name a few, all trade at or below market multiples for the broader S&P 500 $SPY despite being perhaps on the cusp of structural growth. See charts of PEs and FCF vs SPX below.

23/ As I've written below, the upcoming decade's market leaders are unlikely to repeats of the last. One of the main ways to achieve long-term gains is identifying a promising theme trading at attractive valuations before it becomes a consensus long.

https://twitter.com/StuLoren/status/1435721174009499652?s=20

24/ The defense spending theme also fits in the broader context of my view that things we truly need are undervalued relative to those we simply just want.

https://twitter.com/StuLoren/status/1438509174065799169?s=20

25/ The world is becoming more complex, with American geopolitical dominance arguably waning. History would suggest that we are in for more turbulent times ahead. I'd suggest positioning some portion of investment portfolios accordingly. The end.