February
13, 2002, 8:00 a.m. Be
a Theme Player
Think
defense before you invest.
he
inability to get a good stock market rally going can be attributed to
a combination of Enronitis, the absence of a fiscal stimulus package,
and continued earnings disappointments across the "growth stock"
spectrum. Where will the next investment theme emerge that will lead to
sustainable growth in revenues, earnings, and stock prices? What event
will set the stage for such a secular move in stock prices?
Astute
market observers won't have to go too far to identify past relationships
that have a high potential to produce successful stock investments. The
driving force to beating the market in today's environment is neither
a top-down economic approach nor a bottom-up stock-picking approach. Without
another enormous boost from a technology-like boom that gave us a bull
market in the second half of the 1990s, the economy won't see 4% growth,
so making a top-down case for stock investing is difficult. On the other
hand, a case for a bottom-up approach may be frustrated by the general
unsustainability of trends in an extremely competitive economic environment.
As a result, stock pickers will be challenged when it comes to buying
and selling within a small universe of growth stocks that go from under-valuation
to over-valuation and back again.
One option that makes
sense in a difficult economic environment is theme investing. This is
an approach that identifies a sector of the market that benefits from
some external influence. This influence can have a variety of origins
but has the power to benefit that one sector well above the market in
general. One influence that has that ability in today's market environment
is the political mandate. A political mandate is a government decision
that has broad and long-lasting effects on industries either through a
commitment to increase spending (a positive effect) or to increase regulation
(a negative effect).
The political response
to the September 11th terrorist attacks has dramatically changed the landscape
for the defense sector. President Bush's reaction to the terrorist attacks
— essentially to declare war on terrorism and single out an axis
of evil — will have an effect similar to the one that followed President
Reagan's declaration that the Soviet Union was an evil empire.
In 1981, while I
worked with Arthur Laffer, the well known supply-side economist, I came
in contact with a major in the U.S. Air Force who was stationed at the
Pentagon. In those days Laffer Associates, the economic consulting firm
of Dr. Laffer, produced economic and market-related research that was
sold to the financial community. As a result of research conducted by
this Air Force officer, the firm published a lengthy economic report entitled
"The Defense Industry."
The essential thesis
of this report was that the U.S., under President Reagan's guidance, would
fight a new cold war in a way that would ultimately bring about the collapse
of the Soviet Union. The idea was that the U.S. would launch an enormous
increase in defense spending that would force the Soviets to do the same
to protect themselves against the possibility that the U.S. could defeat
them in a conventional war. Reagan's idea was quite simple — the
U.S. would force such a diversion of resources into defense that the balance
of the Soviet economy would collapse as a result.
In 1981, this new
political mandate provided an obvious investment opportunity: Invest in
a broad range of defense stocks that will benefit from that political
mandate. For the ensuing years up until the fall of the Berlin Wall, that
investment strategy proved enormously profitable. When I look back on
the stocks that Laffer Associates identified as major plays on that political
mandate, it was easy to see that investing in the right theme proved unusually
rewarding.
Today is hardly different
than 1981. Only some of the players have changed. The U.S. commitment
to eradicating terrorism is no different than President Reagan's unannounced
intention of collapsing the evil empire. As long as terrorism remains
a threat to world peace then the mandate for it's eradication would dominate
defense — either in the form of defense spending or in the form of
spending on homeland security. So, for investors seeking long-term growth,
the defense industry is one solid place to do some research.
— Tom
Nugent is Executive Vice President & Chief Investment Officer PlanMember
Advisors, Inc.
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he
inability to get a good stock market rally going can be attributed to
a combination of Enronitis, the absence of a fiscal stimulus package,
and continued earnings disappointments across the "growth stock"
spectrum. Where will the next investment theme emerge that will lead to
sustainable growth in revenues, earnings, and stock prices? What event
will set the stage for such a secular move in stock prices? 
