Core military markets have generally been understood to be “counter-cyclical,” Loren Thompson wrote this week on Forbes.com.

But, what happens when the three main drivers of military demand – threats, politics and the economy- all all stuck in second gear?

With the economy, defense contractors lose either way, Thompson writes. If a solid rebound of business activity occurs, defense spending will still remain flat and investors will leave defense stocks to earn higher returns.

If the economy continues to stall, that flattening may turn into more serious spending reductions and fewer contracts.

The appeal of low tax rates and large cash holdings can only appease investors for so long, said Thompson.

“Defense executives need a new paradigm for how they deploy capital” to the respond to new market realities, Loren writes, as “policymakers are more interested in getting bargains than helping industry make profits.”

Some argue that defense contractors will respond by divesting and spinning-off some operations and by making other moves to rally around core operations.

Thompson disagrees, and argues that the future defense landscape will actually lead to diversification, not consolidation.

Defense contractors, he contends, will actually begin to fill into growth areas that are fueled by federal policy, but are also driven by substantial civilian and commercial demand.

He identifies General Dyanmics‘ recent $960 million acquisition of healthcare IT provider Vangent as an indication of the kind of diversifying acquisitions and financial realignments that will define the landscape.

He also recently noted that Lockheed Martin has established a new executive post to pursue cyber contracts as the company has recently streamlined its information technology operations to center on networks, information services and software.

“As frustrations mount with the tenor of government-industry relations, almost all of the big defense contractors will probably move to reduce their military exposure,” he says.

“The information revolution has made even Raytheon a pretty complicated story.”

Ultimately, defense firms cannot hold tight to their core business and hope to retain the same margins they have historically generated. “Cutting costs… will only work for so long” in a world where there are increasing success stories with “a foot in both doors.” We’ll see how it plays out.