PALO ALTO, Calif. (CNN/Money) -
Except for those who make a special effort, investing generally isn't about morality. It's about intelligently predicting which companies will make money and boost their stocks.
That's why it's a better idea than ever to think about investments associated with the war on terror, war with Iraq and whatever next war the Bush administration dreams up.
The big thinkers at Merrill Lynch, under chief U.S. strategist Rich Bernstein, have been pushing defense stocks for more than two years now. Their prescient call in mid-2000 was that investors should overweight defense-oriented companies and underweight technology. Turns out they believe more than ever that defense will be stronger than tech, and they've got an interesting twist on why.
The Department of Defense used to make all new and innovative technologies classified, or top secret, according to Kari Bayer Pinkernell, senior U.S. strategist at Merrill. That's why technologies like the global positioning system (GPS) and the Internet started out in the defense community.
Then, with the end of the Cold War, the government de-classified all sorts of things, and the boom of innovation during the 1990s happened in the private sector, primarily in Silicon Valley.
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"Now," Pinkernell argues, "the government is going to once again re-classify technology, putting the private tech sector at a huge disadvantage."
The Merrill folks have straightforward business reasons for underweighting tech (a fancy way of saying that they think you should own fewer technology shares than everyone else does -- the S&P weighting currently is just under 15 percent).
"There's still a tremendous amount of overcapacity and very little consolidation in technology," says Pinkernell, who estimates that despite the spate of mergers and the flood of bankruptcies there are 75 percent more tech companies than there were in 1995. "There are too many companies fighting over a shrinking pie."
Defense is the new tech
How to play defense, then? Pinkernell suggests the best way isn't in the big defense contractors, whose stories are well known and whose businesses are complex -- and often tied to commercial aviation.
Instead, she points to some of the smaller companies on the buy list of her colleague, Merrill defense analyst Byron Callan. See the table at right for six of them.
The most valuable of these, Alliant, is worth about $2 billion, making these defense stocks pygmies in the war business. (Merrill discloses potential or actual investment banking conflicts of interest with every last one of these companies.)
It's sad to be focusing on companies that make money by fighting wars. But if the strategy is sound -- and it seems so -- Merrill's argument represents yet another leg in the anti-technology stool more and more investors ought to consider sitting on.
Adam Lashinsky is a senior writer for Fortune magazine. Send e-mail to Adam at lashinskysbottomline@yahoo.com.
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