Wargaming World War Three: how and where the next global conflict could actually unfold

Reuters defence commentator Peter Apps, a British Army reservist, assesses a 30-35% probability of a third world war within the next decade, identifying potential flashpoints including Taiwan and the Baltic states (Estonia, Latvia). His view and new book signal elevated geopolitical risk that could push higher defense spending, disrupt supply chains and increase volatility across equities, commodities and FX, suggesting investors should adopt risk-off positioning and scenario plans for defense, supply-chain and energy exposures.

Analysis

Market structure: A rising probability (30–35% over 10y per the piece) of major state conflict structurally reallocates spending toward defense, energy security and cybersecurity. Direct winners are large prime defense contractors (LMT, RTX, NOC) and defense ETFs (ITA); losers include global travel & leisure (RCL, UAL), container shipping and EM export-oriented equities. Pricing power shifts toward suppliers of specialized military kit and non-China supply-chain nodes for semiconductors; commodity supply threats push oil and gold higher in risk-off spikes.

Risk assessment: Tail risks include a Taiwan conflict disrupting TSM (TSM) production (low-prob high-impact), sanctions fragmentation hitting multinationals, and insurance/reinsurance shocks. Immediate (days) effects will be USD/gold bids and equities risk-off; short-term (weeks–months) could raise oil +15–30% on chokepoint disruptions; long-term (years) implies elevated defense budgets but also higher borrowing and fiscal strains. Hidden dependencies: integrated civil-military supply chains (aircraft MRO, semiconductor equipment like ASML) mean indirect winners/losers beyond headline names.

Trade implications: Expect safe-haven rallies in US Treasuries and gold initially, then commodity-driven inflation pressures that lift energy equities; volatility (VIX) will spike, favoring long-dated options for convexity. Tactical plays: overweight large-cap primes, hedge with short cyclicals and buy oil/gold call spreads; use event triggers (e.g., maritime closure or sanctions announcement) to scale exposure within 48–72 hours. Catalysts that could reverse moves: diplomatic breakthroughs, rapid de-escalation or decisive deterrence signaling.

Contrarian angles: Consensus may overpay defense multiples—past spikes (post-2014) delivered mean reversion once procurement timelines and budget constraints became clear. The market underprices stagflation risk from prolonged conflict; long-only defense without commodity/interest-rate hedges is exposed to rising yields. Historical parallels (Cold War arms cycles) show 12–36 month lag between budget announcements and contractor revenue, so front-loaded valuation risk exists.

Key Decisions for Investors

• Establish a 2–3% portfolio overweight in ITA (iShares U.S. Aerospace & Defense ETF) with concentration trades of 1% LMT and 1% RTX long; scale in over 6–18 months, add on >5% sector pullbacks, target a 15–25% return if defense budgets accelerate within 12 months, take profits at +30%.
• Initiate a 1–2% short position in RCL (Royal Caribbean) or a 1% short basket of UAL + AAL to hedge travel/demand shock; place stop-loss at 12% adverse move and target 20–35% downside within 3–9 months if maritime/tourism disruptions occur.
• Buy a 3-month GLD call position (ATM +5–10% strikes) equal to ~1% of portfolio and a 3-month WTI $85/$100 call spread (via USO or options on CL) equal to ~1% to capture commodity spikes; roll or realize winners if gold > $2,100/oz or WTI > $90 within 90 days.
• Hold 3–5% of portfolio in USD liquidity via 3‑month T‑bills (laddered) and maintain a 1% allocation to 2–3y Treasury ETFs (SHY) as tactical flight-to-quality; if PLA naval/air activity occurs within 100 nautical miles of Taiwan or shipping closures are announced, increase defense/commodity exposure by +50% within 48–72 hours.