The Long and the Short of It: 2020's Smartest Defense Plays

Do you remember 2019? The "good old days" when a Trump tweet or some minor development in the trade war with China could send stocks, sectors, even the entire Dow up or down 4% in a day?

With the rhythm of life radically changed, with so much time spent in isolation these days, it seems like the calendar itself is losing its teeth. Is today Tuesday? Friday? Neither?

As for me, last summer feels like 40 years ago; my mind somehow blends an August 2019 trip to Tahoe with my Reagan-era Little League baseball games.

But as investors, we cannot for a second afford to believe time has stopped or slowed. The clock is still ticking; the calendar still packs a punch, even if we're feeling that differently in our personal lives.

With a few notable exceptions, like Brazil and India, much of the rest of the world is emerging from its pandemic-induced freeze, at least for the northern summer.

Countries competitive with and even hostile to the United States are having a "moment." Sensing vacuum and opportunity, they are jockeying for advantage in a world where the sole military superpower is, let's say, "otherwise occupied."

Yet the market has radically mispriced this fact and all its implications; the flood of stimulus means markets are otherwise occupied, too.

This is creating some double-digit upside opportunities at double-digit discounts...

Geopolitical Explosions Are Ignored and Underpriced Right Now

I have to be blunt: The markets, "high" on stimulus, are overlooking the very real possibility of conflict in 2020 and beyond.

It's by no means a pleasant thought, but, again, it's something we have to get to grips with - and if we do that before everyone else, we'll be in position to make big profits for little risk.

We have an important consideration here: The United States' military and defense budget.

I think, regardless of which party wins the 2020 elections, the defense budget will, at minimum, remain untouched at its current $721.5 billion level. Even under a President Biden, I can envision some scenarios that may see that figure increase.

That's because it's obvious even to Congress that China is moving in the Pacific and South China Sea. The People's Republic has a three-year head start on terrifying hypersonic missile technology; many D.C. insiders I know are concerned about this, to put it mildly.

Likewise, Russia has beaten American companies to the punch on hypersonic technology; Vladimir Putin is currently staging a bit of a spending spree around technology.

There are real cybersecurity concerns in regards Russia and China, too, and the Pentagon will, with Congress' blessing, continue to pour increasing dollars into research and development.

So we want to locate trades that have lower implied volatility - ignored by the broader market.

To get a better sense of how the market is pricing risk and what Wall Street thinks about current conditions, I turn to the BlackRock Geopolitical Risk Dashboard.

BlackRock Inc. (NYSE: BLK), the largest investment fund in the world by assets under management, created this dashboard as an effective pricing tool that measures the market "shock" after a major event and provides forecasts for the possibility of major events.

Right now, BlackRock's risk indicators are very high on tensions across South Asia, the possibility of fragmentation across Europe, and global trade tensions.

Surprisingly, BlackRock's analysts aren't too worried about North Korea, or any flare-ups in Latin America. We'll see...

A Long-Term Hold in a Changing World

Money Morning Defense and Tech Specialist Michael Robinson just pinpointed 20 stocks he believes could double or even quadruple in a year as 5G moves closer to reality. (Click here for his research and to learn how you can get the names of these 20 stocks.)

But, more than that, Michael has spent decades covering the U.S. military - a huge catalyst for and beneficiary of technological advancement.

This week, we heard from Michael on the one-year anniversary of one of the largest mergers ever for the American defense sector.

The 2019 merger that created L3Harris Technologies Inc. (NYSE: LHX) created a $35 billion company that does $16 billion a year in revenue.
One of the key things that Michael pointed out was that the company specializes in cell-site simulators, which look like cell phone towers but actually steal signals from intelligence agencies, capture suspect movements, and triangulate locations.

Even now, 21st century warfare requires an incredible amount of data processing; it was vital in the pursuit and elimination of enemy warlords like Osama bin Laden and Abu Bakr al-Baghdadi.

Michael calls L3Harris Technologies a "must-buy security play" that taps into the growing arms race around hypersonic weapons and the new U.S. Space Force.

This is critical given increasing concerns about Russia's testing of the Kosmos 2542/2543 anti-satellite weapon (ASAT). Earlier this year, the Pentagon was alarmed to find Kosmos "stalking" its USA 245 Keyhole spy satellite, and there are real worries the space-borne Russian weapon could attack or disable U.S. or allied satellites.

L3Harris also provides enterprise-level cybersecurity services that also help insulate it from the traditional "boost and cut, boost and cut" military spending cycle.

LHX shares currently trade around the $169 level, but I think this stock has what it takes to go to $230 in the intermediate term. I'd put a price target on the stock at roughly $230. That represents a 36% climb from current levels.

A Short-Term Cyber-Defense Payoff

As I noted, I'm paying close attention to the BlackRock political risk calculations on a daily basis.

One of the most surprising takeaways right now is that the market is also discounting the possibility of a major cybersecurity breach.

I'm stunned that cybersecurity concerns are muted, given the fact that the United States has a very significant and potentially very different election approaching - and that the U.S. economy has effectively moved online.

To capitalize on complacency, we can lean on Michael Robinson's extensive background in cybersecurity coverage to address a great short-term trade for readers.

The HACK ETFMG Prime Cyber Security ETF (NYSEArca: HACK) is the first and largest exchange-traded fund (ETF) that tracks the performance of the cybersecurity industry.

The ETF holds a large basket of cybersecurity stocks that are vital to the defense of the U.S. economy, military, and government. Now, ETFs have their drawbacks and advantages, but if we're exploiting an unaddressed, ignored concern, I'd say it's best to own the broader ETF than try to focus on one specific company.

We're doing some short-term speculating on the increasing concern of a major breach - cast a wide net here.

Right now, the HACK Dec. 18, 2020 $47 call is trading at $3.20, or $320 for 100 contracts.

If your risk appetite is lower, I would recommend placing a limit order on those calls for $3 and waiting for it to fill by selecting "Good Til Close."

The risk here is that the ETF doesn't go to $50 and you lose your premium - but with the probability of this trade finishing in the money at 45% and the market's ignorance to a broader breach.

Your profit target here is a 30% to 40% gain by September 2020, and I'd head for the exits if the options trade down to around $2.40.

I think the rest of 2020 is going to be eventful. The risk of conflict is rising with each day the United States remains mired in pandemic. If - or, as I think, when - that happens, investors who are in front of the markets are going to come out on top.

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About the Author

Garrett Baldwin is a globally recognized research economist, financial writer, consultant, and political risk analyst with decades of trading experience and degrees in economics, cybersecurity, and business from Johns Hopkins, Purdue, Indiana University, and Northwestern.

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