Investing in a world of war

Don’t obsess about geopolitics, but be alert for changes caused by a more tense and volatile world

Given the worsening state of the world, it seems jarring that markets are holding up as well as they are. Every month brings fresh evidence that we are in a far more dangerous era than we were for the last three decades, but stocks keep reaching fresh highs in the US and are not doing too badly elsewhere (certain pockets, mostly emerging markets, are an exception to this). Yet this shouldn’t be a surprise. Markets shrug off geopolitics more easily than we assume, as Robert Buckland, the former chief global equity strategist at Citigroup, notes in the Financial Times.

“As an equity strategist, I learnt to be aware of geopolitical risks, but not over-obsess,” he writes. “That is because they usually make me depressed, and hence too bearish on markets… I do not mean to trivialise the humanitarian consequences of recent events across the world, but a professional lifetime advising investors has taught me that bad geopolitics do not always mean bad stockmarkets.”

Hedge against tension, not disaster

There is sense in this. Yes, the worst-case scenario if international relations keep deteriorating is serious – but if that happens, the stockmarket is the least of our worries. So it’s rational to remain a bit optimistic, not least because there’s a limit to what can be done to protect your portfolio. In a state of widespread open war, everything would be subverted to the interests of the nation. Expect rates to be cut, bond yields to be capped, corporate profit margins to be scrutinised and foreign investments to be restricted.

However, a situation of ongoing global tension is rather different. We’d assume is that it promotes volatility and inflation, as global trade fragments

and supply-chain security trumps cost-cutting. On an asset-class level, this might benefit gold, energy and raw materials. On a sector level there are many potential beneficiaries from shifting priorities, but the obvious one is defence.

Western politicians are belatedly becoming aware of something that should have been selfevident two years ago – if they want to fight wars, they need to increase capacity in the defence sector, which has shrunk since the Cold War. This week, Keir Starmer spoke of increasing defence spending to 2.5% of GDP. This is still low – during the Cold War, Nato members averaged above 3% and the US about twice that – and will probably be just a start. I don’t like this trend, but we need to acknowledge new realities.

The HANetf Future of Defence (LSE: NATP) and VanEck Defense (LSE: DFNG) exchangetraded funds, which hold both defence hardware and services such as cybersecurity, have done well since listing in the past year. European defence firms – such as Rheinmetall (Frankfurt: RHM), Thales (Paris: HO), Leonardo (Milan: LDO) and Saab (Stockholm: SAAB-B) – include some notable winners already, but one could imagine them doing particularly well if Donald Trump were to become US president again in November. EU leaders might be forced to accept the need to strengthen the region’s defences, meaning greatly increased spending for their national champions.