Global Armaments
Why Now?
circa 1915: A woman munitions worker operating a machine in an armaments factory during the First World War.
(Photo by Hulton Archive/Getty Images)
Let us examine the question of armament spending thru our applied history framework, which we see as a practical tool that uses the laboratory of the past to better understand and navigate the complexities of the present and future.
Thousands of years of military history show that robust armament spending is fundamentally linked to preventing conflict. It builds the military strength necessary for effective deterrence, discouraging potential aggressors who calculate that the costs and risks of challenging a well-armed and resolute nation are too high. Weakness or insufficient investment in defense, conversely, makes conflict more likely by lowering the perceived barriers to successful aggression.
Once kinetic conflict starts, as invited by a lack of deterrence, there is often a reactive surge in armament spending particularly in democracies that may have reduced spending during peacetime. This is driven by the immediate needs of the war: replacing lost equipment, producing munitions, mobilizing personnel, and developing or deploying necessary technologies to counter the enemy.
With this backdrop, what do we see today?
We see the retreat of globalization and the reemergence of regionalization.
We see that armament spending is at multi century lows due to the flawed assumption that we had reached the End of History (a very influential book in the halls of power that was published in 1992 i.e. victory day for Cold War 1, that said we are now at the End of History because liberal democracy is the final form of government for all nations).
We foresee that unchanging human nature will likely remind us all that failure to deter invites kinetic aggressors and when its invitation is accepted it is often accepted by multiple invitees which then reignites a reactive surge in armament spending.
The current invitees that have accepted have been Russia and Hamas/Iran so far.
Source: Department of Defense, Worldbank, Marzian and Trebesch (2024), Hedgeye Risk Management
Using our applied history framework, which we see as a practical tool that uses the laboratory of the past to better understand and navigate the complexities of the present and future, let us examine more precisely how various financial markets behaved in past periods of nation state kinetic conflict.
The first age of globalization and what happened between its hegemon Great Britain and its rising power and challenger Germany is an excellent starting point.
Notice the material percentage increases in armament spending that also coincided with large increases in government borrowing relative to GDP. Then notice over this buildup period before the start of World War 1 (1914) that those who held their sovereign’s bonds had losses between 23% and 30%.
Source: Niall Ferguson in Pity of War
This of course bodes poorly for bond exposures during the build up period. Now let us examine what happens after the war starts.
Notice the massive increase in the money supply across all participants from 110% for the UK all the way to 1,102% for Russia. This all took place over just six short years and thus shows the absolute decimation of one’s purchasing power over the period. A similar conclusion can be seen in cost of living indices as well. This should not be a shocking result when one sees the magnitude of deficit spending over the war period and the cumulative amount of debt incurred to fight it.
It was not just men’s bodies that were conscripted to fight. It was also the population’s collective purchasing power and wealth that was conscripted to fight for victory.
Source: Niall Ferguson in Pity of War
However, it is false to say that performing your patriotic financial duty means you must accept being debased and rendered poorer.
There were plenty of other exposures you could have taken that provided immense value to the war effort and also resulted in your wealth growing in real terms.
Source: Niall Ferguson
Clearly having long exposure (making money when prices rise) to select equities and select commodities while having short exposure (making money when prices fall) to select bonds would have done immensely well. Why?
Long Select Equities-Wars cannot be won with words alone so companies that make more guns, tanks, shells, etc are incredibly valuable. Those who can make more gear at reasonable cost and at reasonable quality can empower the armies to achieve their objectives.
Long Commodities-Supply disruptions combined with increased demand causes prices to skyrocket which then incentivizes reordering production for its highest and best use.
Short Bonds-In many ways, a modern war is between each nation’s industrial base i.e. a war of the factories. Thus the nation than can produce more relative to the other increases the odds for victory. To produce more and quickly means to borrow more money and or to create more new money. This results in the accelerated debasement of the currency and as such the real value of bonds are eroded away.
Thus, there are better ways to build portfolios in the context of a wider aperture of potential conditions that are only visible if one looks deeper into the historical past and thus perceives the conditional factors that favor or disfavor certain exposures.
Whether its equities, bonds, or commodities there is a danger in the assumption of permanent unchanging exposure as opposed to a conditional one based on an applied history framework.
Perhaps it was simply random chance how equities, bonds, and commodities behaved as they did during WW1.
Let us now explore other conflict periods like WW2 and the Korean War.
Equities
There are a mix of equity markets that did well (naturally those countries who won) and those that did not do well (naturally those countries who lost).
For bonus points, if your equity exposure was tied to producers of key war time materials (like US Steel which produced steel or Anglo-Iranian which produced oil) you performed exceptionally well.
Bonds
As previously discussed, the vast majority of cases show that bonds lose material value leading up to and into the conflict period.
This is absolutely true for the loser in the conflict and is often the case even for the victor.
Remember, the sovereign not only conscripts its people but also its people’s purchasing power.
Commodities
There are dramatic commodity price moves (both sharp rises and sharp falls) thru the entire lifecycle of the kinetic conflict (start, middle, end).
Again, the combination of a top down applied history framework with a bottom up quantitative process to determine when to go long (making money when prices rise) and when to go short (making money when prices fall) proves vital.
Source: Global Financial Data, Niall Ferguson
Thus, we are left with the conclusion that there are strong tailwinds to global rearmament given our applied history framework.
Moreover, our ability and willingness to go both long (making money when prices rise) and short (making money when prices fall) across multiple asset classes of equities, bonds, commodities, and currencies gives us a greater opportunity to compound wealth in service of each financial plan despite what normally would derail it.
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