Is It Time To Turn Bearish On Defense Stocks?

Before the recent economic downturn and the election of the Democratic Obama administration since 2001 United States and European defense contractors had done fairly well compared to the rest of the market. Boeing (BA) for example was at 50 in June, 2005. It peaked at just over 100 in October, 2008. (Data from Boeing Investor Relations). Since then it has declined to 44.85.

At the same time durable good orders in the U.S. have also declined to an almost thirteen year low as unemployment expands to levels not seen in twenty-five years. This drop is mainly been driven by auto manufacturing and defense production. If there will be a contraction in U.S. defense spending as is really expected after 2010 then this will seriously affect contractor production and revenue.

For some companies the future does not portend well as an example with the 2010 budget proposal two major Boeing programs are recommended for termination — Future Combat Systems (FCS) and the F-22 Raptor advanced fighter aircraft. Lockheed Martin lost the VH-71 Presidential Transport Helicopter too. These trends has led Barron’s recently to cut their ratings on several defense companies from buy to sell.

Boeing itself has said that they feel that defense spending in the U.S. has probably reached its top and will decline from now on. This is also true in Europe as financial difficulties have led to declines in tax revenue and increases in social and stimulation spending. England like the U.S. is facing the biggest problems and has already discussed ending buys of the A400M transport and the Typhoon fighter.

Does this mean it is time to dump these companies? One consideration is where to move the money to? While there has been a recent rally over the last several weeks it is hard to believe unless there is a major turnaround in the economy that it will continue. One major concern that has not yet made itself felt is inflation. These factors may weigh on the stock market in the future.

There is also a chance that the Obama administration will have to rethink its plans for defense spending especially with the challenge that North Korea and Iran are now posing for the world. If they do look at holding spending steady or increasing it in target areas this may lead to better performance for the large defense contractors. There is also the idea that when one program ends another starts and this means that there are still requirements for systems and somebody has to make them. If Boeing goes down maybe Northrop will go up.

The end result of all this is that in the short term it is best to hold and see how things shake out with the budget in Congress and with Obama’s plans.

For more on these types of issues see these other posts:

England Faces Downgrade On Debt Rating, Is The U.S. Next?

Gates Moves Quickly To End Boeing And Lockheed Programs