The best defence is military stocks

There is some disagreement at the moment as to whether the world's stockmarkets are near the end of a bear-market rally, or at the beginning of a long bull run.

It's impossible to say with any real conviction which way things will go. So, given the uncertainty, it is probably worth making sure your portfolio is positioned a bit more defensively than usual. One way to do this, says Michael Sivy on CNNMoney.com, is to consider putting some money into companies operating in the defence sector itself.

This makes sense because the performance of defence stocks has "little to do with short-term economic events". Instead, it is connected to long-term geopolitical issues and national foreign and domestic security policies, all of which are working in its favour at the moment: since 2001, defence spending in the US alone has risen 35% and the amount of cash being poured into homeland security budgets has risen exponentially.

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Before September 11th, 2001, homeland security barely existed as an industry, says Steven Lord on Forbes.com. But for the fiscal year 2006, the US government has budgeted a massive $60bn for homeland defence. No wonder the sector is seeing "explosive growth".

So how can investors best take advantage of this surge in spending? One answer is to look for opportunities beyond conventional weaponry: modern warfare and terrorism have prompted the development of a wave of high-tech pieces of equipment. Soldiers will soon be able to rely on robot vehicles to scout out areas for them so they don't have to remain in exposed positions for long; various new kinds of lightweight but stronger-than-ever armour are soon to reach battlefields; and the British army has even found a technical solution to the problem of a scarcity of military bugle players. A new instrument has been produced that looks identical to a normal bugle, but which plays the fanfare at the press of a button, allowing the "player" to mime instead of actually playing, says Paul Matthews in the Daily Mail.

This may appear insignificant, but it illustrates a common trend: a need to use technology to keep costs down, given the rising pressure on budgets in so many battlefronts. In the US, for example, the new instrument is believed to have been introduced to help the US army cope with the rising number of full military funerals requiring the Last Post over the last few years.

Technology is also being increasingly relied on in the West's fight against terrorism on its own turf, particularly when it comes to surveillance. Take scanners, say Brian Brady and Richard Gray in Scotland on Sunday.

Old-fashioned airport metal detectors currently use 30-year-old technology and are far from reliable. However, the newest generation of scanners can sweep across an entire airport or station concourse at speed, picking up anything suspicious as they go. They use terahertz radiation, a relatively unused range of frequency between infra-red and microwave radiation originally developed by QinetiQ, the defence research company, as an MoD project aimed at helping pilots see through thick fog.

Increasing concerns about domestic security are also driving demand for products such as CCTV systems, particularly now that companies are producing cheap and easy-to-use digital systems that can be networked and viewed from anywhere in the world the market for these, says Shares magazine, is currently worth "maybe £100m a year and is growing rapidly due to security concerns".

The three best stocks in the sector

FLIR Systems (FLIR), the world's largest provider of thermal-imaging equipment and night-vision cameras, is worth adding to your portfolio, says Steven Lord on Forbes.com. The company's growth has been "phenomenal", with sales doubling since 2001 to $482m last year. Earnings per share should reach $1.20 this year and $1.41 the next, and with a 28% return on equity, $100m in cash and low debt, the firm has among the best financial position of any defence-related stock.

Another company to consider is American Science & Engineering (ASEI), a provider of security and inspection systems. These are used to scan people, baggage, cargo, vehicles and other objects for weapons, explosives, drugs and other contraband, including radioactive materials the "next big problem" the US needs to tackle. ASEI's growth has been "exponential": earnings per share in fiscal 2006 should reach $2.72, versus $1.25 for fiscal 2005. The firm has no debt and trades on a p/e of 15 times forward earnings with a p/e to growth ratio of 0.8, making it an "excellent addition" to any security-related portfolio.

Shares magazine likes defence and space software specialist Vega (VEG). The firm said that it is "on track" with its targets, thanks to large new contracts. It may beat its profit forecasts and on a p/e of 12, the shares still look "an excellent opportunity".