With the war in Ukraine now in its third month, some of its impact on the markets is already known, while other economic consequences are still developing. The disruptive effects of international sanctions against Russia have been severe for the Russian economy and have also been felt more widely on the global stage. With continued volatility plaguing investors and no clear path to resolution in Ukraine, it is an important time to revisit what these present conditions may mean for our longer-term outlook for our client portfolios.
While the cost of war in terms of human suffering is immeasurable, the business of war is undeniably lucrative. One of the clearest potential beneficiaries of protracted conflict and rising geopolitical tensions is the defense industry. Since the collapse of the former U.S.S.R. in 1991, many Western nations, including the United States, have been underinvesting in their own defense in light of the lower level of perceived geopolitical risk in the years that followed. However, not long after Russia’s initial invasion of Ukraine in February of 2022, the U.S. and several other Western countries either increased their defense spending or pledged to do so, including Germany’s recent headline-making increase in its military spending to more than 2% of its gross domestic product (GDP). These tremendous financial flows will pay for things like increased personnel, facilities and operations of national militaries, but in large part they also will be used to buy equipment, munitions, aircraft, vehicles and more, all of which will be provided by a defense industry that is ready and waiting.
In looking at defense contractors both in the U.S. and abroad, we believe that some of them are currently very well positioned as an investment opportunity not only over the course of the current conflict, but potentially long beyond it as well. Many of these firms have invested substantially over the years to create significant manufacturing platforms that they can quickly deploy to service the increased demand expected both domestically and overseas. While defense spending may have stagnated to some extent over the past few decades, these firms have nonetheless made tremendous strides in developing technologies like missile systems, electronics and communications systems that are now broadly considered indispensable tools for modern militaries.
The growing demand for these wares will be critical in the years to come not only to help backfill the equipment, munitions and other supplies of those countries who have helped to supply the Ukrainian army and will now need to replenish their own resources, but also to fulfill nations’ increased defense needs in light of rising global threats, whether in Russia or beyond. For defense contractors that have already built out their manufacturing capabilities and are well placed to respond to these rising and well-funded demands, we believe their ability to leverage even small upticks in orders can have a powerful impact on their shareholder value.