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Tough political talk fires up defense stocks

24 May 2016 in Trading Ideas

Key Takeaways

  • The presidential campaign has seen both candidates advocating a strong U.S. military.
  • America’s allies may need to step up defense spending, which could boost sector sales.
  • Motifs mentioned: Modern Warfare
  • Stocks mentioned: Lockheed Martin (NYSE:LMT), Raytheon (NYSE:RTN)

This year’s presidential election has seen both presumptive candidates making the case for a strong military – and that’s apparently been a good thing for investors in defense stocks.

The Modern Warfare motif has risen 2.7 percent in the past month. In that same timeframe, the S&P 500 fell 0.2 percent.

In the last 12 months, the motif has gained 15.4 percent; the S&P 500 is down 3.7 percent.

On the Republican side, likely nominee Donald Trump has promised that “we will spend what we need to rebuild our military” because “our military dominance must be unquestioned.” As for the Democrats, Hillary Clinton has pledged to “ensure the United States maintains the best-trained, best-equipped, and strongest military the world has ever known.”1

See much difference there?

That could mean a win-win for investors no matter who’s elected. As Daniel Clifton, head of policy research at Strategas, told CNBC.com, “the way I think investors are thinking about this election is infrastructure [spending] is going to go up no matter who gets elected. Defense is going up no matter who gets elected.”

This isn’t all necessarily campaign rhetoric — the list of global military threats isn’t small. Russia in the last few years has annexed a slice of Ukraine, moved into Syria, and thumbed its nose at NATO by rehearsing a 33,000-troop strong invasion of Norway, Finland and Denmark. (Fun!) Marketwatch columnist Paul Brandus noted that Moscow even threatened Denmark with a nuclear attack if it joined the alliance’s missile defense system (it did anyway).2

Meanwhile, China’s construction of bases in the disputed South China Sea has raised the stakes in Asia, as has ongoing nuclear and missile tests by dependably undependable North Korea.

Then, of course, there’s the Middle East, where the Islamic State is active in both Syria and Iraq, and U.S. allies in the region remain worried that the recent nuclear deal with Iran will merely fuel the country’s regional ambitions, including its support for terror groups like Hamas and Hezbollah.

Passing the check

In the wake of the global uncertainty, it’s interesting to note that Trump has actually called for the U.S. to reduce its global security commitments in both Europe and Asia while asking America’s allies to do more – and pay for more — themselves. But that scenario can also serve defense contractors – even in the wake of domestic spending that was cut by the federal sequester mandate – as they’ll be the ones supplying foreign countries that boost military hardware purchases.

To some extent, it’s already happening. About 20 percent of Lockheed Martin’s (NYSE:LMT) revenue came from overseas last year, according to data from FactSet cited by CNN.com, with the top spenders being Japan, Germany and the UK. And more than 30 percent of Raytheon’s (NYSE:RTN) sales came from outside the U.S. last year, led by Japan, Turkey, India and Saudi Arabia.3

In the Middle East, American allies such as Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates have spent $33 billion on arms purchases in the past year.

Some analysts believe NATO spending is only beginning to pick up on both side of the Atlantic. Even after the strong run for defense stocks, “it makes clear to us that 2015 is the bottom of this cycle for defense industry revenue,” Stifel Nicholaus analyst Joseph DeNardi noted in a recent research report.4

A significant part of that growth could come from Asia. By one estimate, South Korea is now paying about 30 percent of the cost for large U.S. military presence in the region. Now, pressure is increasing for Seoul to fit more of the bill. In Japan, government leaders are moving away from the country’s traditional post-World War II defensive military force toward one that can counter potential aggression by China and North Korea.5

The extra spending there and in Europe could even pose more upside for the stocks of defense suppliers.

  1. Annie Pei, “Bellicose campaign rhetoric is sending defense stocks soaring,” cnbc.com, May 9, 2016, http://www.cnbc.com/2016/05/09/bellicose-campaign-rhetoric-is-sending-defense-stocks-soaring.html, (accessed May 23, 2016).
  2. Paul Brandus, “Opinion: Global jitters mean good times for defense stocks,” marketwatch.com, May 17, 2016, http://www.marketwatch.com/story/global-jitters-mean-good-times-for-defense-stocks-2016-05-17, (accessed May 23, 2016).
  3. Paul R. La Monica, “What sequester? Defense stocks near all-time highs,” cnn.com, May 12, 2016, http://money.cnn.com/2016/05/12/investing/defense-stocks-trump-clinton/index.html, (accessed May 23, 2016).
  4. Paul Brandus, “Opinion: Global jitters mean good times for defense stocks,” marketwatch.com, May 17, 2016, http://www.marketwatch.com/story/global-jitters-mean-good-times-for-defense-stocks-2016-05-17, (accessed May 23, 2016).
  5. ibid

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