Scott Sacknoff's  Instablog

The  Chase for Ten

Historically, aerospace and defense cycles can run 12-15 years. And for nine years running, the SPADE Defense Index has outperformed the broader markets. Even after huge gains by financial stocks since the March market bottom,defense stocks trailed the S&P 500 by just 3.5%at the end of August but have been making up ground lately.

A number of end-of-year events could aid the sector -- namely the start of a new government budget year, Boeing’s plans for the firsttest flight of the 787, and news that the QDR will show that future budgets will be flat and without major declines. All are positives.

Year-to-date, the stock performance of the sector has been dampened as investors speculate on what changes will appear in the QDR and we hit an anticipated peak in defense spending. In addition, twice as the market was beginning to climb higher, the run stalled based on the timing of news -- Boeing’s announcement shifting the 787 first flight schedule and Congress cancelling one jet fighter program in favor of another. 

As the defense budget is restructured and several large initiatives are cancelled / delayed in favor of newer ones there is PR impact but “the devil should be in the details.” For example, cancelling the F-22 was big news and  impacted the share price of Lockheed Martin but with the Pentagon’s plan to allocate dollar-for-dollar the resources to Lockheed’s F-35 fighter, the real impact was less than the media promoted. Initiatives related to unmanned vehicles, cybersecurity, persistent surveillance, etc. continue to provide opportunities for new business and increased competition.

Still after nine years of outperformance, the question for investors of course is, can the Index continue its run in what has been a negative news year. A third of the year remains and there are signs that the next few months could be a positive one for aerospace and defense companies. All’s Quiet on the Analyst Front
 

As the sector awaits firm news from the QDR and future budget details, investment analysts covering the sector have been very quiet. A search for recent analyst forecasts or comments on the sector revealed little. Here are two we found:

* Douglas Harned of Bernstein Research raised price targets on several aerospace firms stating that “Rising demand could help establish a recovery more quickly than in previous downturns...unlike previous periods when airlines placed orders after one year of profitability, orders now are already in place and the market is grappling with less excess capacity. Backlogs are now double what they were at similar points in earlier cycle.

Market Drivers

* Ryan Fuhrmann, CFA, stated, “In today’s stock market, defense is one of the few industries where investors can find appealing valuations and solid underlying business fundamentals to move portfolios forward.