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The Inertia Of Defense

|Includes: The Boeing Company (BA), COL, DPRK, GD, HRS, ITA, LMT, NOC, RTN, UTX


The momentum play on defense stocks has been pushing them to new all time highs. Will the event of war, or even the non-event of non-war bear a correction?

DPRK has been a "buy on the sound of the cannons and sell on the sound of the trumpets" situation what will likely happen going forward?

United technologies buying Rockwell Collins is signaling a top in the defense sector.

Lockheed Martin Corporation (NYSE:LMT), Boeing Co (NYSE:BA), Northrop Grumman Corporation (NYSE:NOC), Raytheon Company (NYSE:RTN), General Dynamics (NYSE:GD), Harris Corporation (NYSE:HRS), United technologies Corporation (NYSE:UTX), Rockwell Collins Inc (NYSE:COL),   iShares U.S. Aerospace & Defense ETF (ITA)

    Post the attack of Nine Eleven defense stocks started what is now a sixteen year upswing.  Almost every defense equity is reasonably sitting at or just below their all time highs.  Reasonable after this huge upswing because a Republican president in office wants to rebuild and modernize the military.  The sustained and continued effort to combat extremism in the Middle East is now coupled with talk of war on the Korean Peninsula.  There are also aggressive ramblings stemming from Eastern Europe as well as the South China Sea.  Defense stocks have good earnings, good dividends and good demand for the products they sell.  However Mr market has a way playing his own game at his own choosing.  

    A conflict in North Korea has been explained by top U.S. brass to be devastating like nothing we have ever seen before.  A sustained ground battle in the Democratic Peoples Republic of North Korea (OTC:DPRK) has been referred to as suicide.  DPRK has thermonuclear weapons and is a very mountainous country that has been digging underground basses and tunnels for fifty years. There are supposedly four long major tunnels leading to South Korea from North Korea.  Talk of DPRK's intercontinental ballistic missiles (ICBM) there range as well as their accuracy has been filling the news.  Some experts suggest a greater threat that is less known is the large possibility of protected silo or underground nuclear, conventional,chemical, and biological weaponry. The greatest worry for South Korea is being pummeled preemptively (to counter a U.S. preemptive strike) by smaller easier to hide, maneuver, and manufacture weapons previously mentioned that would obliterate Northern South Korea.  A preemptive strike on DPRK by the U.S. or attacking them first would surly be an attempt to demolish and maybe even wipe out somewhere between most to all of North Korea.  Harsh and ugly words or thoughts but in reality there is a good chance DPRK with fifty years of tunnel digging and underground base building.  Would sustain a large scale combined conventional and nuclear attack and still be capable of mass devastation upon Northern South Korea as the capital city Seoul is only Artillery fire away.  A prolonged ground war be it invasion, liberation, or regime change effort is off the table and pointless in a nuclear war were both sides plan to devastate each other in a way that the other side would not exist.   Some have started to speak of the world learning to except a nuclear armed North Korea.  There is not much talk about it now but civil society learned to except a nuclear armed Russia, China, France, Israel, India and Pakistan.  If the rhetoric calms I would suspect the world excepts a nuclear armed North Korea as well.  As with all other nuclear armed countries without an antagonistic first strike a nuclear conflict will be avoided.  The South Koreans with a new president Moon Jae-in who helped architect the sunshine policy (an olive branch approach) for dealing with the DPRK is not pushing for war and will give negotiations more time.  I expect this approach will lead to a better armed DPRK that eventually makes war with the country too bloody.

    Many deals especially big deals are done at the top of the market or near the top of the market.  As raising capital for acquisitions is easier and less expensive in good times and oppressive in bad times even though the assets are valued lower.  The latest defense deal with United Technologies buying Rockwell Collins is one of the last signals in what has been largely a sixteen year bull-run for defense stocks.  I would not call the top today but think we are near the limit in this particlur sector.  Cost averaging out of the space or into shorts I think is prudent at this time.  That being said "buy the cannon sound and sell the trumpet sound" (1810 quote by Nathan Rothschild).  Will reverberate into silence as war is avoided the deficit limit debates (now around December) renew Republican fiscal conscience and budgetary restraint.  So the momentum play of Defense stock starting in 2001 is nearing an end.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.