Defense Sector Set to Outperform S&P 500 for 8th Straight Year

Last week while attending the Super Bowl of Indexing meeting in Phoenix (a major financial/investment sector meeting), I chatted with several pension fund and money managers who not only were familiar with the Index but who’ve put money into the Powershares ETF tracking it. Obviously they were quite pleased with the performance and, to a person, all seemed to believe that the sector will continue to outperform through at least the November 08 elections.

What I found interesting were the comments that they made related to the resilience of the defense sector following recent market corrections and the fact that the market issues related to the subprime loan crisis, the decline in the dollar versus international currencies, even the possibility of recession in 2008, has less of an impact on defense and homeland security companies than many of their other investments. In addition to providing superior returns over the past few years, these investors were looking at defense as a hedge to the current uncertainty in the market and they expected to maintain their investments in it for some time--my thoughts exactly.

As we’ve begun to think about 2008, we notice that more and more analysts are stating that they see an element of stability in the political arena as politicians (those in office and those seeking office) continue to support the sector. Since political change is the biggest risk to the defense sector, stability is welcome. The shift of control in Congress from the Republican party to the Democratic party had some worried, but the last year has seen little impact on overall defense spending as well as to how current and future programs are evaluated.

While we will do a more extensive recap in January, we’d like to point out that three of the sector’s top gainers have more than doubled in price YTD with the top 20% of the Index all above 50% gains. Top gainers this year include EDO (EDO) (who received a buyout offer from ITT), FLIRSystems (FLIR) (whose stock is up more than 100% and which is due to split in December), and Stanley, whose stock has doubled due to recent contract wins.

On the downside, defense ITfirms--CACI, SI International, and MTCTechnologies--have suffered as DoD continues to direct funds toward Iraq. Meanwhile Force Protection saw its stock decline nearly 40% in November as the Marines reconsider the number of MRAPvehicles it is purchasing. Armor producer Ceradyne (CRDN) and heavy truck manufacturer Oshkosh Truck (OSK) also saw double digit declines in November.