Hillary Clinton and Donald Trump will exert a more assertive foreign policy than President Obama. But before the new administration flexes its administrative muscles, the defense sector will already be in a growth phase and defense stocks are responding.
Bolstered by renewed Congressional backing, increased threat levels worldwide and the US military’s need to upgrade its arsenal, the sector is leaving the squeeze imposed by the Budget Control Act (BCA) of 2011 and into a more favorable environment.
“We’re in the early stages of an up-cycle,” said Joseph DeNardi, a defense analyst at Stifel Nicolaus.
The S&P Aerospace and Defense Index has consistently outperformed the S&P 500 since mid-2005. From 2009 to 2013 it beat the market by about 30 percent. From 2013 onwards it pulled up even more to where it currently sits, beating the S&P 500 by 47 percent and up almost seven percent since the start of the year.
Since the beginning of the Bush presidency, defense spending has risen dramatically, peaking in 2011 at $719 billion, a large portion of which turned into industry profits. Later the same year, with federal spending soaring and revenues falling, House Republicans refused to increase the debt ceiling in a tussle with Democrats resisting cuts. The result: a fiscal standoff and the Budget Control Act of 2011 which has forced budget caps ever since.
Defense leaders called it “a doomsday mechanism” but even with limits, Congress has pushed up the caps allowing increased defense spending. Now they’re poised to rise even more. Fitch Ratings issued a positive forecast saying “continued solid spending levels in FY2017 and beyond are expected.”
“Everyone agrees, at least on the Armed Services Committee, that there’s a need for more defense spending,” said a defense policy analyst who asked to remain unnamed due to current political work. He said that excluding a few hardline fiscal conservatives and stragglers on the left, most of Congress wants sizable increases.
Meanwhile, on the campaign trail, Clinton called on her website for “ending the sequester for both defense and non-defense spending” while Trump has said he will “make our military so big, so powerful, so strong that nobody — absolutely nobody is going to mess with us.”
Fiery rhetoric brings breathless headlines, but it won’t be until FY2018 that either candidate will really influence the budget. Congress passed a Continuing Resolution (CR) on September 28th funding the government until December 9th while a post-election “lame duck” session should secure finding through next October 1st.
But world events are already doing plenty to fuel the flames and drive the market up.
“It’s threats that drive defense spending,” said Richard Safran, defense analyst at Buckingham Research. “And you have some really well established conflicts.”
These global challenges are concerning the military’s top brass who see the need for investment in overdue upgrades and expansions.
The Navy lacks the ships needed to maintain the presence it wants oversees while many Air Force jets are over 20 years old. The United States has maintained dominance primarily through superior technology, so with Russia and China (never mind North Korea) rolling out a stream of new capabilities, it’s up to contractors like Raytheon (RTN) and Northrup Grumman (NOC) to keep the nation’s military at the top.
“Raytheon is our top pick now,” said DeNardi. “There’s a lot of technology that they’ve learned over the past few decades with a product portfolio focussed mainly on missiles, missile defense, electronics and radars.” Raytheon trades at $137.13, up 10.8 percent since the year’s start and 11 out of 15 analysts rate outperform.
Industry leader Lockheed Martin (LMT), with annual revenues in excess of $45 billion, hit its highest stock price ever in August while its F-35 Lightning II fighter jet promises continued huge profits. It’s trading at $236.60, up 8.7 percent since the start of the year with four analysts rating buy and 11 rating hold- caution because Lockheed Martin has tripled in value since 2013, and such fast growth can’t be sustained.
In this environment, defense may soon be hitting new milestones.