Budget and economic issues are expected to pressure defense spending for the next several years. After a year of constant negative news regarding possible budget cuts to defense, when the dust settled, the sector held steady with the benchmark SPADE Defense Index, down just 2.75%.
The question is… when and what would lead to a shift back toward security spending and benefit defense contractors such as Lockheed Martin (NYSE:LMT), General Dynamics (NYSE:GD), Raytheon (NYSE:RTN), Northrop Grumman (NYSE:NOC), and CACI (NYSE:CACI) or ETFs such as the Powershares Aerospace & Defense ETF (NYSE: PPA)?
Recent news and analyst forecasts for 2012 can provide insight into that.
Threat #1: Iran
Whether its threatening to shut the Straits of Hourmouz and disrupt the world’s energy suppliers or threats to use nuclear weapons on neighbors such as Israel; or the possibility that Israel could pre-emptively destroy facilities in Iran before they can be used to create global devastation; and the region is highly unstable and threat #1 on most people’s list.
Threat #2: The Arab Spring Aftermath
Throughout 2011, people of nations throughout North Africa and the Middle East sought greater freedoms and overthrew oppressive regimes and those not assisting the economic needs of the populace. The problem is the old-saying regarding the devil you know. What will evolve in the region – more stable democracies, religious rhetoric, a new military leadership group, or turmoil and chaos – is still to be seen.
Threat #3: North Korea
The death of Kim Jong Il also puts the Asia region into unfamiliar terrority with a new leader taking control of a government that oppresses its people and has access to rockets and nuclear material.
Threat #4: Iraq
We left, so isn’t everything stable? Not really. The U.S. was a stabilizing element between parties that have been in conflict for generations. The abensce of the U.S. in the region keeps an element of instability.
Threat #5: Hackers and Cybersecurity
When you depend on technology – economically and militarily – protecting it become more and more critical. Increasingly, people gaining access to databases and systems are becoming commonplace. While more of an annoyance at the moment, the threat is significant which is why it is gaining so much attention.
Threat #6: Pakistan
The weakness of the government to remove radical elements from its territory has created a division within the nation between those aligned with more with the West (U.S. and Europe) and those who focused on regional power and the Taliban. Ultimately anytime a nation has rockets and nuclear weapons and the possibility that elements of the region could overthrow or destabilze the local government and the situation generates fear.
Threat #7: China
China has been flexing its muscles and using resources from its economic growth to fuel development of a 21st century Navy, Air Force, space program, etc. The fear that China could become a true threat similar to what the Soviet Union represented from the 1950s-1980s is generating a lot of attention. The reality is that the near-term likelihood of them going on the offensive is relatively small (outside of course in their own backyard, ie. Taiwan, for example). Still, eyes need to be focused on any nation seeking to become a world power with the resources and technology that China possesses.
Threat #8: The Unknown
Globalization has brought greater awareness of events around the world. However the increasing ease of the spread of information can enable threats that 100 years ago would not have been possible. For many, the events of 9-11 and the possibility of suicide bombers on U.S. soil, were not envisioned. Neither were the Oklahoma City bombings, the events in London, Madrid, etc., or the actions of a lone lunatic in Norway. Diligence can only go so far.
Ultimately, there is no greater function of government than to protect its people and its way of life. As long as Congress remembers that, cuts to defense spending may happen from time-to-time but the cycle of growth will return.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: The author manages the SPADE Defense Index (NYSE: DXS), an investment benchmark containing companies operating in the aerospace, defense, and homeland security sector. DXS is the underlying index for the Powershares Aerospace & Defense ETF (NYSE: PPA)