A good fisherman knows both how to fish and how to avoid those times when the weather is so bad that all fish hide. Ditto investing: Good investors know both how to pick stocks and how to recognize the times when the investment climate is so bad that they'd better stay cautious and hedged.
In the last column ( , I provided a list of economic factors that are akin to weather barometers: When these go to an extreme, you'd better stay close to shore. Since April, these factors have been advising caution.
But the world is not run by economists. It is run by heads of state who control aircraft carriers, bombers and combat troops, all of which they sometimes use for economic reasons - like protecting oil wells and oil routes. Therefore, just as markets can once in a while turn economically risky (or advantageous), so can they turn militarily risky (or advantageous).
Please note, though: In normal times, you should tune out such external factors - after all, you invest in stocks, not in their environment. But when environmental parameters get to extremes, you'd better pay attention. And over the past few months, not only economic indicators, but military conflict indicators, too, have been flashing orange.
What are these?
Naturally, there's no "conflict database" similar to the Federal Reserve economic database (FRED), to which I once referred. Rather, you should use the same principles you'd employ in stock sleuthing and analysis: Follow physical changes and look for extremes. For example, just as big increases in corporate inventories can be risky for a stock, so can large increases in military "inventories" in the oil-producing Middle East signal a higher war risk for the market.
The odd thing is, even when such military concentrations occur, they aren't always reported in the North American media, perhaps because the public has no interest. But if you follow the world press, you can find out such facts - and recently such military hardware movements have been accelerating, hinting at potentially higher risk ahead.
For instance, last month the U.S., British and French navies held an unprecedented joint exercise in the Mediterranean, and right after, the U.S. aircraft carrier Truman and its 10 accompanying battleships crossed the Suez Canal to join the two other U.S. carrier groups already in the Gulf. Even more interesting, two weeks later an air caravan of American and Israeli cargo planes landed in Azerbaijan, downloading "equipment," which caused the Iranians to protest loudly and go on war alert.
Such force concentration near the oil fields doesn't mean a conflagration is imminent, but it does mean the risk of one has gone up, with possible investment implications.
What sort of implications?
For real stock bargains, probably none: If you find a great business selling at two times cash flow, go ahead and buy it. Bargains do not come up very often. However, for non-bargains, worsening military factors - similar to today's worsening economic factors (such as negative real rates) - should make you require a higher margin of safety when you do invest in non-bargain stocks.
But remember: The rising movement of military hardware is only an indicator of higher risk, not a sure sign that a military conflagration is imminent. And even if the gathering opposing forces do come into conflict, this could paradoxically signal a market bottom, as it did twice before: In both Gulf I (January, 1991) and Gulf II (March, 2003) the market declined for months into the conflict, but rose briskly afterwards.
I remember 1991 especially well, because at the time I was with Gordon Capital, which, together with partners, made a bid for a lovely junk bond portfolio of several prime U.S. corporations. Since the market then had been declining for close to a year (after a military buildup in the gulf - just like now), the junk bonds could be bought for a song, and so we bid a mere $2.35-billon. Unfortunately we didn't get the bonds: Apollo Partners did. I am saying unfortunately, because once the first Tomahawk missiles were fired, both the bond and stock markets roared up too and never looked back. Anyone who bought when the Gulf I war broke, would have been rich before the end of the decade. (Yes, Apollo made a mint.)
Gulf II was similar: 2003 saw the market plunge right into the beginning of hostilities in March, then the Gulf I scenario repeated. The market zoomed, and anyone who had bought when fighting started would have done very well.
So when you see today's heightened conflict factors, remember that in investing as in fishing, just as fish hide before a storm, so do they come out after it. Yes, it is prudent to stay close to shore now, but remember Gulf I and Gulf II and get your rods and lures (i.e. your lists of stocks and cash) ready, because if hostilities do break out yet again, chances are the stock-picking then would be terrific.
Avner Mandelman is a director of Venator Capital Management and author of The Sleuth Investor.