Geopolitics Puts This Industry in Spotlight

There’s no mystery here. The industry being referenced in the headline is aerospace and defense and there’s no mystery as to why this group warrants investors’ attention over the near-term and beyond.

In a span of less than 10 days, US forces shutdown four objects that entered North American airspace. That started with the now infamous Chinese spy balloon with three more yet-to-be identified objects taken down after that. A friend of mine put it well: The Air Force’s F-22 Raptor, produced by Lockheed Martin (NYSE: LMT), is now the world’s most expensive BB gun.

Underscoring the vibrancy of the defense investment thesis, the approximate cost of a single F-22 is $150 million. That’s nearly quadruple the price tag on the now retired F-14 Tomcat made famous by the original Top Gun. Oh yeah, each sidewinder missile fired from an F-22 costs $400,000. Advisors and clients may already be aware of that factoid because, as confirmed by a slew of media outlets, the most recent object that was shot down, required two attempts, costing taxpayers a cool $800,000.

Leave the assessments of aviation proficiency to those paid to deal with it, but the fact remains that aerospace and defense is a viable talking point for advisors when it comes to client conversations. Here’s why.

More Than Infiltrating Objects

Recency bias is factor for advisors to deal with, but the good news is there’s much to the aerospace and investment thesis than simply the Chinese balloon being spotted over the skies of Montana.

“Since then, three more unidentified objects have been removed from the sky. Meanwhile, retaliating against the price cap on Russian crude exports by the EU and G7 countries, Russia decided to cut its oil production by 500,000 barrels per day starting in March. The news sent WTI oil prices back above $85, benefiting energy stocks last week,” notes Anqi Dong of State Street Global Advisors (SSGA).

Still, there’s no denying the impact that near-term geopolitical events have on aerospace and defense stocks. Take the case of the SPDR S&P Aerospace & Defense ETF (NYSEARCA: XAR). That exchange traded fund is higher by 2.22% over the past week and by 10.51% year-to-date.

However, an asset such as XAR is buoyed by more than near-term events. In fact, the ETF and its peers could be credible inflation fighters, despite being overlooked as such.

“While the US economy remains challenged by stubbornly high inflation, softening demand overall, and weak corporate profits, the outlook for the aerospace & defense (A&D) industry remains positive,” adds Dong. “The optimistic outlook has been bolstered by increases in spending. The recently passed National Defense Authorization Act for Fiscal Year (FY) 2023 authorized $858 billion in defense spending — $45 billion more than President Biden requested, and 10% higher than the FY 2022 amount. NATO has also increased its 2023 military budget, 26% more than its 2022 level.”

Favorable Price of Admission

When considering the favorable traits offered by some aerospace and defense equities, some clients are apt to assume the group is richly valued. Actually, the opposite is true and that statement is bolstered by hard and fast data as well as A&D’s residence in the industrial sector – a value destination.

“Despite the industry’s 34.5% outperformance over the broad market last year, the A&D industry’s relative price-to-book (P/B) ratio remains well below its long-term median, and below the median level during the last defense spending cycle that took place between 2001 and 2011,” concludes Dong. “This indicates potential value alongside elevated growth prospects.”

Bottom line: Near-term geopolitical issues are helpful to the A&D thesis, but there’s more for advisors to discuss with clients when it comes to this industry and that’s a positive.

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