Credit: Shutterstock photoIf I had to provide just two words of guidance to investors about 2017, I would say "expect change."
The new administration will soon be shaking things up in a manner not seen for many decades. There will likely be a loosening of regulatory oversight, a massive uptick in infrastructure spending, and a substantial increase in defense spending as America takes a more hawkish stance on global affairs.
While each of these expected macro changes will create opportunity and risk for investors, some of the best opportunities will be created in the defense sector.
Over the last five years, defense spending has been stifled under the Budget Control Act of 2011. Despite the cuts, the largest firms in the aerospace and defense sector have weathered the storm remarkably well. If you look carefully, this success was only possible with aggressive management action. Stock buybacks, workforce cuts, and ramping up efficiency have all been effectively used to survive.
Defense firms have also sought profits via foreign markets and commercial businesses while neglecting their core defense competencies. Even worse, budget cuts have curtailed long term planning, as it's difficult to take on contracts in an uncertain funding environment.
But this tide might be turning. Donald Trump has repeatedly stated that he plans on removing the caps on defense spending. And since the government will be unified under Republican control, it is likely that Mr. Trump will be able to carry through with his plan.
The Aerospace Industries Association is suggesting that base defense expenditures rise from the $539 billion agreed to in the recent National Defense Authorization Act for 2017 to $620 billion in the fiscal year 2018 defense budget.
Retired Lt. Gen. David Melcher explained in December 2016, " The outlook for our industry is strong. We have continued to grow sales and exports, and we're on track to exceed the positive trade balance of $81.6 billion we recently posted. But we could be doing much better. The artificial constraints imposed by the BCA caps hamper our industry's ability to support national security and undermine our nation's ability to invest in the future. "
Hopefully, some of you were able to catch the Presidential election defense stock cycle in 2016. In seven of the past ten presidential election years, U.S. defense stocks outperformed the benchmark S&P 500 index to a substantial degree. Multiple defense stocks are up 25% to 30%, compared to the S&P's 20%.
Traditionally, defense stocks go flat in the years after the Presidential election. However, I firmly think this year and beyond will be much different for the reasons above.
I have identified two companies that are expected to continue to outperform in the defense/aerospace sector: General Dynamics (NYSE: GD ) and Raytheon (NYSE: RTN ) .
Headquartered in Falls Church, Virginia, General Dynamics is a diversified aerospace and defense company with a market cap of nearly $53 billion. Riding on the back Trump's win, the stock is trading near the top of its 52-week range in the $176.00 per share zone. In fact, shares are up over 14% since the November election alone.
Excitement surrounds the company's core competency in submarine building with the $100 billion Ohio Class ballistic missile submarine program. This program is part of the Navy's order of 355 crafts, up from the original request of 305. They are also building two of the Virginia-class submarines each year.
Right now there is over $40 billion allocated just to submarines over the next 5 years, so I fully expect the uptrend to continue in General Dynamics.
My other pick, Raytheon, is a provider of defense electronics, missiles and integrated defense system for ships. The company boasts a market cap of $43 billion and is also trading near its 52-week high in the $145.00 per share zone. Shares are higher by almost 20% over the last 52 weeks, and the uptrend appears in great shape to continue in 2017.
Ratheon is best known for its Patriot Missile Defense System. Patriot is a long-range, high-altitude, all-weather solution that has been meticulously tested more than 2,500 times with U.S. Army oversight under real-world conditions. It can counter threats from tactical ballistic missiles, cruise missiles, drones, and advanced aircraft.
Most recent bullish news is that Raytheon just received a $600 million defense system upgrade contract from an unnamed nation. The company has 13 customer nations that have spent just under $8 billion since the end of 2014 on the Patriot missile defense system.
As the United States ramps up spending, Raytheon should continue to thrive in the global defense market.
Risks To Consider: Trump's stance on increasing defense spending remains unproven. Right now, it is nothing but campaign rhetoric. Time will tell if he follows through with the promises.
Action To Take: Both Raytheon and General Dynamics should make significant long-term gains from their current trading levels.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
