Q&A Interview with Scott Sacknoff of the SPADE Defense Index (NYSE: ^DXS) Discussing Sequestration and its impact on the Defense sector and Defense Stocks
Point Roberts WA- March 11, 2013 (www.investorideas.com newswire, www.homelanddefensestocks.com ) Investorideas.com, an investor research portal specializing in sector research including defense and Homeland Defense stocks issues a recent interview with Mr. Scott Sacknoff of the SPADE Defense Index (NYSE: ^DXS), the underlying index for the Powershares Aerospace & Defense ETF (NYSE: PPA).
Scott Sacknoff discusses his impressions on the sequestration and its impact on the defense sector and defense stocks.
Mr. Sacknoff, several months ago you mentioned that until the sequestration was resolved you planned to be pretty quiet, why is that?
A: Sacknoff: That's true. Last year I said that until all the sequestration and budget issues were resolved, how defense stocks would response was just a guess. Calling a bottom without knowing where cuts were going to come from, which programs would be impacted, and as importantly, when they'd be impacted makes evaluating companies and stocks more difficult that normal. That said, there were a number of strengths in the sector - international exports, growth in commercial aerospace, cybersecurity, and great balance sheets with tremendous cash positions and I thought these factors would offset the flattening and declines in the defense budget. But sequestration was a wild card. Recognizing the stabilizing factors means little when the government throws a monkey wrench into your calculations. So instead of guessing, putting out an opinion didn't seem right.
So, sequestration took effect. Were you surprised that Congress didn't fix the issue?
A: Sacknoff: Not really. I thought it was a horrible idea and its execution will cause lots of problems whose impact won't be felt for months, but nothing Congress does (or doesn't do) really surprises me anymore. Democrats thought he Republicans would budget and they called that bluff and decided enacting budget cuts were more important than supporting the defense sector.
And what did happen in the market?
A: Sacknoff: Well, despite constant media attention on the fiscal cliff and sequestration the SPADE Defense Index (NYSE: DXS) managed to outperform the broader market, gaining 16.3% in 2012. And it's up 5% more to start 2013, 52-week highs. So those that said, they will ride it out and collect the dividends, which for the Powershares Aerospace & Defense ETF was a bit above 2.0% according to Yahoo, they were happy they chose that path. Still, the market reaction instead of ignoring sequestration could have focused on the impact and drop in GDP and stocks could have easily have fallen. There was something else I did find unusual.
What was that?
A: Sacknoff: Well, I believe that in an unknown environment, owning a fund for diversifications reasons instead of holding an individual stock makes sense; especially if you are unsure which companies would be impacted the most. Yet over the past several months, the opposite appears to have happened. As the stocks, and of course the funds, moved higher, so people were obviously buying the sector, the number of shares held in the various funds declined. It's a shame because when you compare the performance of companies such as Lockheed Martin (NYSE: LMT) and Boeing (NYSE: BA) with the Powershares Aerospace & Defense ETF (NYSE: PPA) for example, and investors would have benefited from being invested in the fund.
So, where do you think things are headed from here?
A: Sacknoff: There is still a fair amount of unknowns however some things to keep in mind. A Continuing Resolution to fund the government at 2012 levels through September is currently being debated. This would provide DoD with $518 billion in nonwar funding plus an additional $87 billion for overseas war-on-terror activities.
Now, many people outside Washington would think is a good thing, yet the problem with a CR is that not only do the budget numbers remain fixed but what their spent on is fixed as well. Picture if you budgeted $20,000 for a new car in 2012 and being told 'here's another $20,000 to spend for a car in 2013' even though you didn't need one and would rather spend the money on fixing your heating system. It does appear though that Congress will give the Pentagon some flexibility to allocate funds with some limited flexibility. Investors should keep in mind though that anticipated defense spending reductions over the next several years will take us, roughly, to the levels seen in 2007, levels much higher than after 9/11, near the beginning of the last defense spending build-up.
Also, sequestration reductions won't mean the canceling of previously awarded contracts and the agency is going to find as many non-essential areas to cut as possible. The first cuts announced will be closing the military's worldwide commissary network one extra day each week and issuing partial furloughs to 15,000 military school teachers and staff. So, for at least the moment, the impact on public defense stocks is delayed.
Lastly, what do you think the play is for 2013?
A: Sacknoff: Personally, I'd expect aerospace suppliers to produce solid gains and for Boeing to rebound from 2012's market underperformance once the issues with the 787 batteries are resolved. And I see C4ISR and cybersecurity firms gaining traction in spite of the budget issues at DoD as IT companies such as SAIC, CACI, KEYW, etc gain customers from other government agencies and increasingly from private firms wanting DoD-level security to protect their networks. With cyber attacks up 44% and 75 million pieces of malware on the net, even the banking community has turned to the National Security Agency for advice.
This has been great. Thank you for making the time to chat today.
Sacknoff: My pleasure.
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