The Next Super-Cycle

Defense Spending is just getting started

European leaders predictably agreed to another heap of sanctions on Russia - but just as predictably stopped short of a $50bn in military aide package for Ukraine. Warring powers have been economically strangled before, but with the world’s second largest economy backing Moscow, well… don’t hold your breath, Russia’s economy is on a tear. Fortunately, those overheated war-time economies are more akin to snorting a line of Bolivian marching powder than the sort of run you get from a solid night’s sleep.

It also comes with paranoia. Last month Russia’s very competent central bankers (who knew?) were warning the government that between the US and OPEC rests the capacity to flood the global oil markets. What Moscow fears isn’t that their grain and fertilizer routes through the Black Sea are menaced by whatever Ukraine is calling a navy. What keeps then huffing the vodka is that a prolonged price collapse in energy prices in the 1980’s - that contributed to then collapse of the Soviet Union – will do the same to the current regime.

Moscow’s central bankers are right, up to a point. OPEC’S spare capacity of about 5.3mm bpd is at a record high and equal to Russian’s current exports. Saudi Arabia’s current production is 9mm bpd, and can ramp up to $12mm bpd in a few months. For his part, Trump’s power to force US producers to overproduce is limited. If your survival depends on high energy prices, your biggest danger comes from non-US, non-OPEC producers looking to cash in on fossil fuel's while that's still a thing. Essentially, the fate of Russian, and on the other side Europe, hangs on the willingness of places like Guyana, Brazil and Kazakhstan to drill like the devil to squeeze all the money they can out of the legacy energy sectors. Which is not a spot anyone would want to be.

While economists are fussing over where global markets might be in the commodities super-cycle, the 4717 is eye-balling an altogether different super-cycle.

You could do worse than defense - because it looks like we’re headed into World War III and will be lucky if all we get in a reboot of the expensive, wasteful and nationalistic Imperial system that prevailed before the US took over. Overall, American defense contractors are looking at solid years aheads, and while they still dominate “the West” they are expensive, troubled and lack the infrastructure to ramp up quickly.

Profits you’d rather not make

After two rotten years of cratering stock prices, crashes and fuselage panel hiccups - Boeing shares are up 11% after winning the contract for the 6th generation F-47. It’s a whizz-bang manned jets that looks set to be the most expensive fighter ever made. The Pentagon hasn’t released cost estimates, and Elon stalking the halls probably isn’t helping matters - he’s famously opposed to the F-35 and other manned fighters in the age of drones. For that matter, he’s opposed to manned cars (although he can’t produce an alternative) and if XAI is any indication, manned thought. As Lockheed Martin is a rival to SpaceX, he’s opposed to a manned Lockheed Martin.

The chatter is that development costs have exceed $50bn and a unit price of hundreds of millions. President Trump has said that “an experimental version of the plane has been secretly flying for almost five years and we’re confident that it massively overpowers the capabilities of any other nation.” Meanwhile shares at Lockheed Martin, which makes the F-35 but lost on the F-47 bid, dropped 10% as Europeans souring on the plane as they grope around for alternatives - with Sweden’s Saab AB Gripen gaining traction for low operational costs and maintenance as well as advanced tech.

Sweden’s wonderfully named prime minister, Ulf Kristersson, announced a jump in defense spending from 2.4% GDP to 3.5% by 2030 - funded mostly through borrowing. With the release of the German debt brake, they aren’t the only ones. German arms-maker Rheinmetall stocks are up 11% this year, double what they were 11 weeks ago and up 12X since Russia's 2022 invasion. Armin Papperger, Rheinmetall’s CEO said the company is now churning out more artillery shells that the entire US at the moment. It doesn’t appear to be quarterly report hot air either. Moscow tried to have Papperger killed by a resurrecting a shadowy, Stalin-era agency called SMERSH, which I’d first heard of in. James Bond novel, whatever that tells you. As it stands, it hasn't seem to slowing down too much.

Papperger can also see the way that the economy and warfare are intertwined: He’s keen on using European parts, materials and tech for the simple reason that a boost in European productivity will boost revenues and the ability to buy more arms. It’s working. The Euro is up 7% against the dollar, and optimism is rising on Germany’s plans to boost infrastructure and defense spending, which will likely spill over into other supply sectors like energy and chemicals. Rheinmetall just overtook Volkswagon in market cap.

The defense boom, which really hasn’t started in full, gunning is the entire European economy, where business has grown at its fastest tick in seven months, with factory output expanding for the first time in two years.

Go East, Young Man.

Europe isn’t the only bloc of nervous US allies looking to re-arm outside of America’s fickle orbit. Defense-industry bosses from South Korean and Australia have been in Ottawa selling Canadians all sorts of military kit; from South Korean submarines and howitzers and Australian cutting edge over-the-horizon radar (JORN) for $4bn. The Pentagon was supposed to be the first in-line for JORN system, but that’s in doubt with cost-cutting taking center stage.

Between Japan and South Korea, arms-dealers revenues have jumped 25% since 2022 - to $63bn. While US arms-makers account for roughly $200bn, and still it dominate the market, East Asian manufacturing can fulfill orders faster than US counter-parts. At Japan’s Mitsubishi Heavy Industry sales are up 20% in Q4 2024. Hanwha Aerospace, South Korea’s largest defense contractor, sales rose 60% year on year selling kit to locals and Europe.

All that weaponry isn’t just for sale - China hasn’t gotten started, but with the US drawback, allies want to be prepared. Last week Beijing revealed its own 6th Gen fighter, the J-36, featuring no tail, three engines for thrust and a host of stealth features.

So to be a complete bastard about it, this defense super-cycle has two possible outcomes: 1) the existential threat of collapsing world order will extend beyond the normal economic cycles, or 2) it won’t. At that point it won’t matter.

What the hell, be an optimist.

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