The escalation of geopolitical tensions continues: as one hotspot cools another emerges somewhere else. And judging by news headlines, it doesn’t look like the situation will improve any time soon.
Analysts predict that in addition to possible turmoil in the form of a major great power war, the Middle East, Western Europe and Asia could all soon become embroiled in new armed disputes.
In the latter case, even if China refrains from forcible reunification with Taiwan, it is not unreasonable to envisage a possible conflict between the two Koreas. A new US versus China proxy theater is also a possibility.
The future does not look much brighter in the EU with fears rising the Ukraine war could spill into bordering states in Europe. Kosovo-Serbia tensions are also on the boil while Transnistria turmoil threatens to resurface.
In the longer term and with potentially more drastic consequences, the European Commission has warned of a possible conflict between EU states over water scarcity.
So does all this real and potential conflict, hostility and turmoil represent a new golden age for military manufacturers? Yes and no.
Indeed, rising geopolitical tensions often translate into higher defense spending as we have seen in recent years. But this alone does not guarantee greater profits for arms makers.
For example, even though the US government is still turning out massive military spending budgets, private defense contractor Lockheed Martin reported lower-than-expected fourth-quarter revenues and a year-on-year dip in profit margins from 13.7% to 12.5%.
Lockheed Martin’s shares fell accordingly by more than 6% last year. Other big US names in the sector did not fare much better.
Northrop Grumman shares, for example, rose by only 2% over the past year while Raytheon Technologies shares fell by around 5%.
So why the disappointing performance?
According to the Wall Street Journal, the Pentagon often issues contracts to develop new weapons systems in which private companies make a fixed profit and the government covers unforeseen costs.
When plans are finalized and weapons are ready for production, the Pentagon often switches to fixed-price contracts, leaving companies in the lurch if costs rise, which they tend to do in the current inflationary environment.
Looking ahead, a severe global economic downturn could cut budgets far and wide, negatively affecting defense spending even when geopolitical tensions are running high.
Moreover, frequent government policy and leadership changes can also disrupt defense sector spending. That’s particularly the case in the US, which is in a heated election season with potential drastic implications for its support for Ukraine, Israel and Taiwan.
For example, if the US withdraws from NATO under a new Trump administration, other member states may feel more or less compelled to maintain high military spending as required under the alliance, especially if they perceive a reduction in threats.
So while big defense contractor shares may look like a sure-fire bet amid heightened geopolitical tensions, the market reality is that many are actually falling rather than rising off the wars.