Defense Sector Strong; Awaiting Final '08 and Upcoming '09 Budget

While President Bush, the presidential candidates and the current members of Congress may differ on the future of the U.S. presence in Iraq, there is consensus on their support for the continued need for defense and homeland security initiatives. Considering this, the likelihood that the sector continues its multi-year outperformance of the broader stock market remains strong. Even now, the Army is planning for 10 to 15 years of possible conflicts.

How strong has the defense sector been? Just check out the numbers. The SPADE Defense Index is up more than 28% YTD and has beaten the S&P500 for eight consecutive years, six by double digits. In four of the last five years, the Index gained more than 19%. Want more? The Index has outperformed the market in 23 of the past 29 quarters and had a negative quarter only 3 times in the last 18. And investors have noticed. Although many still choose to invest in the sector via individual companies, an increasing number are making investments via funds. The Powershares Aerospace & Defense ETF (PPA), which tracks the SPADE Defense Index, has seen inflows nearly quadruple in 2007, rising to more than $400 million in assets.

More importantly is the question of where things are headed. While Congress and the White House battle over the final FY-2008 budget and supplemental spending to cover the costs of the war in Iraq and Afghanistan in 2008, at the end of the day, the agreement they reach will likely appear similar to what is out there today. Once completed, the next major event for the sector is likely to be the early- to mid-January presentation of the FY-2009 budget by the White House to Congress. This will be followed by a release of defense budget-item-specifics which typically are publicized in the mid-January to first-week-of-February timeframe.

From a defense-sector perspective, analysts believe that there will be little surprise to what is already anticipated. With the 2008 presidential elections on the distant horizon, significant changes to the current defense budget before at least mid-2009 appear to be unlikely. Should this analysis remain on track, investors could see several more quarters of performance. But as with all investments, outside factors and unforeseen issues could intrude.