Osama's Death Will Have Little Impact on Defense Sector

Includes: ITA, PPA
by: Scott Sacknoff

I'm sure almost all of us are thrilled that Osama bin Laden is dead. Any time a person as hated and despised as he is brought to justice, the world is a better place. But for those that invest (long or short) in the defense sector, the question is, what now?

The goal of terrorism is to create fear, which is why targets are usually civilian rather than military or political targets. The goal of defense spending is to offer insurance to those in power and/or to the general population (depending on the government in question) as a mechanism to ensure stability.

With that as a basis,

1. Current terrorist acts being planned by al Qaeda:

Little impact. Unless the entire command structure is eliminated, it is likely that near-term plans will continue.

2. Financing terrorist activities

An impact, but to an unknown extent. Terrorist organizations rely on support - financial and political. The question that is unknown is how much financial support for al Qaeda came to the organization because of the man - Osama bin Laden and the personal relations he had - versus those donating blindly to the organization.

3. New terrorist actions

Likely. As in any organization of this nature, there is likely a power play emerging within al Qaeda as several of the 'lieutenants' seek to stake their claim to become the new leader for the movement. There are likely teams of analysts in the CIA and other intelligence organizations trying to determine who (and how many) new potential leaders of al Qaeda will try to step forward. If history and the Mafia are any guide, we can expect that several leadership figures in hiding will be found executed. More importantly, the likelihood that some of these people arrange for bombings or other acts of terrorism to show their leadership value is very likely.

So what does the above mean for investors?

The reality is that the elimination of Osama bin Laden will have little impact on the defense sector and the size of the budget moving forward. U.S. plans to exit Iraq and Afghanistan are proceeding; it is widely known that the near-term budget has peaked; and ongoing plans to reduce spending because of budgetary issues will proceed. There are enough people in Washington DC that recognize that the death of bin Laden doesn't eliminate all threats in the world and they will fight to ensure that spending continues as our insurance policy to protect our way of life.

One only needs to look at the trading of the Powershares Defense ETF (NYSE: PPA) to see the impact of recent news on the sector. PPA is currently hovering around its 52-week high; it was roughly flat Monday, same as the S&P500; and President Obama's speech about two weeks ago regarding deficit reduction didn't have a significant impact either. With the commercial aerospace sector on an uptrend and defense companies that have enhanced their business flexibility to pursue other markets, there is a case to be made for upside potential.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Scott Sacknoff manages the SPADE Defense Index (DXS) which serves as the underlying index to the PPA ETF.