Geopolitical conflict and investing

Nothing introduces more economic volatility in the world than the threat of war.

Today, North and South Korea had a minor skirmish. Normally they have skirmishes once in awhile, but this one resulted in the loss of life from direct land-based artillery shelling, which is different than past skirmishes.

I have been aware of this risk, characterizing it as a “wildcard” in my third quarter report – although I was concentrating on the upcoming Iran-Israel conflict, certainly North and South Korea is another area of the world to look at. South Korea has some very relevant industries that have entered North American culture (for example, my car is a Hyundai, and my laser printer is a Samsung!) and an armed conflict between the two countries would be economically catastrophic, especially for the South.

In terms of the marketplace, other than investing in volatility, an investment in defence contractors may be a hedge against geopolitical risk. In no particular order, the major US defence companies are Lockheed Martin (NYSE: LMT), Raytheon (NYSE: RTN), Boeing (NYSE: BA), General Dynamics (NYSE: GD), and Northrop Grunman (NYSE: NOC). Upon some cursory research, one discovers the valuations of these firms are fairly low.

The reason for relatively low valuations of defence contractors is primary political – most of these companies derive the majority of their revenues from government contracts. With a Democratic-controlled government combined with massive fiscal deficits, one can see why there is a low valuation. Perhaps they are a cheap hedge against geopolitical conflict.

Keep in mind there are small-cap and mid-cap opportunities in the same sector which offer more specific types of exposure, but these typically involve a bit of technology research and knowledge of global military trends.