Financial stocks have, without a doubt, sharply risen since President Donald Trump’s election last November.
But compared to the skyrocketing growth seen in the defense sector, their gains are minuscule in comparison.
As a whole, the defense sector is up 40% thus far, being labeled by and large the best “Trump trade” since November 8th of last year.
One of the biggest driving forces, of course, being continual and ever rising geopolitical tensions, most notably with North Korea.
At the beginning of this month, Trump took to his favorite social media platform, Twitter, to attack North Korean leader Kim Jong Un once again, saying that negotiating with him was a waste of time.
While social media mudslinging might not be the best way to deal with a hostile leader, there’s at least one group that might not mind Trump’s Twitter threats: defense industry investors.
Year to date, the S&P 500 aerospace and defense industry subsector index is up over 30%, compared to a mere 12.9% for the S&P 500 as a whole.
To illustrate the potency of the president’s Twitter power, the defense index subsector climbed 14.3% after Trump issued this Tweet in response to North Korea firing its first intercontinental ballistic missile: “Does this guy have anything better to do with his life?”
While most people don’t fancy the idea of going to war with North Korea, the increasingly heated rhetoric is helping most defense industry stocks reach record highs.
David Chung, a research analyst at Janus Henderson Investors, claims that the more people who are nervous about and afraid of what will happen in the world, the more it drives multiples higher.
And with what we’ve seen with North Korea in recent months, it only elevates the uncertainty even more.
More Military Spending
Not to discredit the president’s social media prowess, but typically, it’s the promise of increased military spending that has the greatest and soundest effect on defense stocks.
While the sector has been outperforming the broader index for a few years now, prices jumped 6.8% in the week after Trump was elected, and they’ve climbed another 31% since then.
The increase is partly due to the Republican Party being seen as more military-friendly, but Trump also said in February that he wanted to increase military spending by $54 billion.
Keeping true to this promise, the Senate passed a $700 billion defense policy bill last month that far exceeded Trump’s original request.
For Dan Gruemmer, a portfolio manager with American Century Investments, those expectations of increased spending and a more defense-friendly president and Congress have not only helped to push stocks, like Lockheed Martin (NYSE: LMT) and Harris Corp. (NYSE: HRS), higher, but they’ve also created inflated valuations for most defense companies.
Indeed, valuations are high, with many defense stocks having price-to-earnings ratios well above 20.
Both Lockheed Martin and Northrop Grumman (NYSE: NOC) — the latter having purchased missiles and satellite-maker ATK Orbital for $9.2 billion in September — are trading at 23 times forward P/E, the highest their P/Es have been in years.
These aren’t the only defense companies to have been performing well, either. Gruemmer says that most defense companies are trading at least 10% higher than they should be.
Then there’s the multibillion-dollar arms deal with Saudi Arabia reached in May.
The transaction was a way to both improve a decadeslong alliance with the world’s largest oil exporter and also potentially lead to additional sales with other countries in the region — from which, most defense giants will likely benefit even further.
Some of the Biggest Gainers
The Pentagon’s largest defense contractor Lockheed Martin clinched a $584.2 million contract for the construction of a littoral combat ship.
Additionally, Lockheed’s Space Systems business unit secured a modified contract worth $419 million for the procurement of Trident II (D5) missile production, D5 life extension production, and D5 deployment systems support.
Moreover, Lockheed Martin has raised its quarterly dividend. The company is going to pay $2 per share in the fourth quarter of 2017, reflecting a 10% rise from the previous dividend of $1.82. Interestingly, this dividend hike marks the 15th year in a row that this defense giant has increased its quarterly dividend rate by 10% or more.
Diversified conglomerate Honeywell International (NYSE: HON) also announced a 12% year-over-year hike (to $2.98 per share) in its annual dividend.
The missile-maker segment of Raytheon (NYSE: RTN) secured a contract worth over $300 million for supplying tube-launched, optically tracked, wireless-guided (TOW) missiles. These advanced missiles will be provided to the U.S. Army, Marine Corps, and foreign military sales customers by late July 2020.
Northrop Grumman Aerospace Systems secured a contract for Japan’s Global Hawk program that’s worth over $130 million.
Per the agreement, Northrop Grumman is going to provide long lead material to commence the program for three global hawk block 30 (I) air vehicles, two ground control elements, improved integrated sensor suite, spares, and a site survey.
The contract is scheduled to be completed as early as late July of next year:
The chart above shows the price movement of the major defense players over the past five trading days and during the last six months.
Over the last five trading sessions, most of the defense giants have definitely put on an impressive show.
However, over the past six months, the entire industry has put on a stellar performance that has been nothing short of showstopping.
Despite What May Come, We Are Safe!
With the president’s Tweets and the North Korean leader’s heated responses — all of this seemingly fanning the flames of the current strenuous geopolitical situation — it would seem that war is an all too real possibility within the near future.
However, I have some good news despite all of this…
Top Boeing (NYSE: BA) executive Leanne Caret stated last month that the current missile defense system the company has would be able to protect the continental U.S. from an attack.
She stated that the system would “do exactly what is needed” to counterattack North Korea should it launch a missile in our direction.
Caret, who is president and CEO of Boeing’s Defense, Space, and Security Division, said she has the privilege of leading the company’s team, developing cutting-edge anti-missile systems.
She calls it a team of “400 protecting 400 million.”
Boeing says it intends to add 44 new interceptors to its system by the end of the year. Caret believes that, ultimately, the new additions will be needed.
There is no doubt that the U.S. has great strength and power. And if it comes to blows with the likes of the North Korean regime, we will be all right.
That’s all for now.
Until next time,
John Peterson
Pro Trader Today