With the looming budget battles and various fiscal cliff issues still just being pushed down the road, the major defense contractors may not seem like a great bet for investors. After all, it’s one of the largest pillars of spending here in the U.S. and many pundits estimate that the sector will face some serious cuts down the road.
Yet, the aerospace and defense sector continues to surge higher.
The reason? Over the last few years or so, the major defense firms have expanded their reach to include more private companies and foreign governments for their products. Meanwhile, the brinkmanship in Washington seems to be fading when it comes to national security and analysts now estimate that cuts to military spending might not be as severe as first predicted.
With many of the budget issues perhaps ending and the global economy finally strengthening, investors should rest assured that the major defense contractors should continue their march higher.
Bipartisanship For National Security
Accounting for over 40% of the world's total military budget, it's no wonder military spending is a hot-button issue in balancing America's balance sheet. However, law makers might be looking elsewhere when it comes to balancing our spending.
Insiders at the Pentagon claim that budget constraints will only allow them to deploy just two brigades of combat-ready infantry in the event of a military crisis. According to their estimations that puts the U.S. at a serious disadvantage in the event of a major issue. The Pentagon believes that seven ready brigades should be the minimum to insure national security.
Well, it seems that congress supports their estimations.
Back in mid-December, a bipartisan group of legislators reached a new two-year budget agreement that would remove about of the previously enacted cuts to the defense budget due to last year’s sequester. The proposed plan provides the Pentagon with $487 billion in baseline spending as well as an additional $85 billion for the Overseas Contingency Budget (OCO). This plan is nearly $5 billion more than the Pentagon originally asked for.
Needless to say, that’s huge news for the purveyors of weapons, aircraft and security systems. Not that they really, need any additional help.
That’s because the defense industry have been branching out into other sectors to diversify away from U.S. military spending. From cyber-attacks -like Target’s (NYSE:TGT) recent credit card woes- to racking up more foreign and NATO contracts, many of the largest defense firms aren’t just a one-trick pony anymore. For example, Boeing (NYSE:BA) still receives more than half of its revenue from its commercial airlines business.
All of these factors should help the defense industry provide a big offense in an investor’s portfolio in the years ahead.
Adding A Dose Of Aerospace & Defense
Given that the major headache for the sector has essentially been overcome, investors may want to consider the defense industry for a portfolio. The easiest and most broad way is through the iShares US Aerospace & Defense ETF (NYSE:ITA).
The fund spreads its $342 million in assets among 39 different aerospace and defenses contractors. That includes positions in industry stalwarts like Northrop Grumman (NYSE:NOC) as well as smaller firms like Orbital Sciences (NYSE:ORB). That broad focus has helped the ETF produce a stellar 11.35% annual return since its inception in 2006. Expenses for ITA run just 0.45%. Likewise, the SPDR S&P Aerospace & Defense ETF (NYSE:XAR) could be a compelling choice. The XAR uses an equal weight strategy- meaning every firm is give the same percentage of the fund’s assets. This makes sure that small firms like AAR Corp. (NYSE:AIR) have the same footing as the larger defense sector behemoths.
Not that there’s anything wrong with being a behemoth. The new spending bill takes care of the larger firms in spades.
A prime example, is venerable Lockheed Martin (NYSE:LMT). Several critics have panned the amount of spending- around $400 billion- on LMT’s new F-35 Joint Strike Fighter program and have called for its reduction. The new budget plan keeps that project operating and all of 2014’s 29 jets and 2015’s 39 fighters will be delivered. The budget also provides for Lockheed to receive a portion of a new $333.5 million dollar contract with United Technologies (NYSE:UTX) Sikorsky to build a new rescue helicopter. Additionally, the budget bill leaves plenty of new contract money with sector stalwarts Raytheon (NYSE: RTN) and General Dynamics (NYSE:GD).
The Bottom Line
With the one of the major hurdles out of the way, the aerospace and defense industry continues to be one of the brightest spots in the stock market. Those overall gains should continue throughout the New Year and beyond. For investors the time could be now to add the sector to a portfolio. The previous picks-a long with L-3 Communications (NYSE:LLL) –make ideal selections.
Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.
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