Stock investors concerned about market turmoil ahead may consider taking a look at seven stocks that could outperform as U.S. defense spending balloons. These companies include Lockheed Martin Corp. (LMT), Northrop Grumman Corp. (NOC), Kratos Defense & Security Solutions Inc. (KTOS), Axon Enterprise Inc. (AAXN), General Dynamics Corp. (GD), Raytheon Co. (RTN) and L3 Technologies Inc. (LLL).
Aerospace and defense stocks as a group have already beaten the broader market this year, illustrated by the more than 30% gain of the SPDR Aerospace & Defense ETF (XAR) in 2019, as noted in a detailed story in the Wall Street Journal. By comparison, utilities, as measured by the defensive Utilities Select Sector SPDR Fund (XLU) have gained 14.9%, and the growth-oriented S&P 500 index has returned 16.6% over the same period.
Defense vs. Utilities
Utilities have historically served as defensive stocks to hedge against an economic downturn. Aerospace and defense contractors are also seen as defensive plays: they rely on federal government spending and are often uncorrelated to a broader stock market that today is plagued by trade concerns and fears of decelerating global economic growth, as outlined by Barron’s. In the most recent month, aerospace and defense stocks have beaten utilities by three-fold, per the Journal.
Rising Defense Budget
Part of the bullishness about this group is due to the positive outlook for federal spending increases. Late last month, the Senate Armed Services Committee approved the National Defense Authorization Act for the year 2020, per the WSJ, including $750 billion for national defense.
Defense spending has been rising for years, leading the largest U.S. defense contractors to post average annual returns of 17% over the last five years, compared to a 13% return for the Dow Jones Industrial Average. Even after their multi-year rally, they trade at 16.3 times estimated 2019 earnings, in line with their longtime average, per Barron’s.
Spending should continue to rise as the U.S. defends its interests more aggressively in the Middle East and directs more money into overseas contingency operations.
These factors are driving the world’s largest defense contractor, Lockhead Martin, whose stock is up 38% this year. The company’s F-35 Joint Strike Fighter remains one of the Department of Defense’s most important programs. Meanwhile, the company continues to post improving capital returns, strong cash flows, and has an attractive dividend yield, one of the highest among defense companies.
To be sure, despite aerospace and defense stocks' attractiveness at this point in the market, this group has swung wildly in the past based on the changing policies and priorities of the White House and Congress. Any major shift in military spending could make many of these stocks unattractive.