Are Defense Stocks About to Run Higher?
December 13, 2021 (Investorideas.com Newswire, HomelandDefenseStocks.com) Scott Sacknoff, President, SPADE Indexes LLC (NYSE: DXSTR) www.spadeindex.com/defense - Global tensions have been mounting in recent weeks as Russia moves troops toward the Ukrainian border, leading some to believe that an invasion is imminent. Meanwhile, there has been an escalation in the rhetoric between the United States and China, the latest volley from President Biden who announced a diplomatic boycott of the upcoming Winter Olympics in Beijing. While human rights issues against the Uyghur people is highlighted by the Administration, it's another step toward the emerging Cold War between the two nations over issues such as Taiwanese sovereignty, military training activities by China in contested areas, and competition on the technology development and business battlefield. Even if nothing more emerges to further escalate these two global situations, defense stocks could benefit and be in play over the coming months.
For most of 2021, from an investor perspective, the defense sector remained quiet. With much of the world's attention focused on the COVID-19 pandemic, the investment news cycle has been dominated by stories about pandemic-related or reopening trades as well as trending tech fields such as electric vehicles, fintech, blockchain and cryptocurrencies, and space tourism.
In the background, three developments related to the defense sector received sparse coverage: (1) The defense budget levels proposed by the Biden White House remained strong, steady, and consistent with prior years; (2) The pullout of troops from Afghanistan quickly faded from the news cycle. Although this had little direct impact on the revenues of public firms, it shifted the focus away from conversations about defense; and (3) Revitalized growth in commercial aviation was curtailed due to the emergence of variants that limited business and consumer travel. Despite this lack of attention, the SPADE Defense Index still gained more than 4% YTD and continues to provide investors with long-term stability and growth. Yet, there has been little news to attract investors to the sector...until recently.
Why do defense stocks rise?
Fear. Uncertainty. It's not just war and direct conflict that drives share prices higher. Often it is the "Winds of War" that leads people to pay closer attention to the sector. President Joe Biden said that democracy faces "sustained and alarming challenges," and, during a virtual summit with representatives from roughly 100 countries, he stated that the trends were "largely pointing in the wrong direction." Taking the position that he would return the US to a global leadership position, he indicated he would face down "authoritarian forces led by China and Russia."
And the "Winds of War" are growing louder. In recent months, the rhetoric has become more tense and heated. China continues to close the gap of US supremacy on the sea and in space. Additionally, defense analysts are raising the alarm over China seeking to build its first naval base on the Atlantic Ocean (in Equatorial Guinea, Africa) and advanced tests of new hypersonic missiles that could evade detection by current defense systems. Meanwhile, the Chinese government is considering a financial attack by forcing the delisting of several firms currently trading on US stock exchanges over what it deems as "national security concerns." And lest not forget about cyber warfare actions, often tied to Russian and Chinese national and entities, which threaten to disrupt the operations of the US government, commercial companies, and civil authorities.
Preparing for an invasion of Taiwan?
The Taiwan Strait is a 110-mile-wide body of water than separates this island nation from continental Asia. A democratically governed nation, it lives under a constant threat from China who has claimed sovereignty over Taiwan since 1949 and maintains that it has the right to seize control under a "unification" policy. In an October 2021 show of strength, a record number of Chinese fighter jets flew sorties that violated Taiwan's air defense zone. Meanwhile, earlier this year, the US Marine Corps participated in a series of readiness training exercises in the Pacific region, including "Noble Fury" off the coast of Japan and "Summer Fury" off the coast of California, to train for a possible conflict.
Regardless of how these militaries flex their muscles, the likelihood that the US would deploy troops overseas to the Ukraine and/or China is limited. President Biden in early December reiterated that he has no intention of sending troops to engage in a ground war. Of course, as an evolving situation, the current philosophy could easily change. While the US has never officially pledged to defend Taiwan, it has committed to the island's self-defense, a strategic ambiguity. Economic sanctions and support for the sale of weaponry are the most likely outcome from a US strategic perspective.
How high can defense stocks soar?
For investors, that is the key question. With history as our guide, since 1997 the sector has undergone very few years with a negative return and only two periods of underperformance. In fact, over the past 24 years, the SPADE Defense Index only saw five years with a negative calendar return-four when factoring in dividends.
Following a period of stock market underperformance in 1998-1999 (though the Index gained roughly 22%), the SPADE Defense Index produced returns that outperformed the broader market in each of the next nine years - five by double digits, more than 1000+ basis points annually. During this time period, investors saw total gains of 161% vs a lost decade for the S&P500 of just 14%.
Following the 2009-2011 period of market underperformance (though the Index gained roughly 30% during that time), the SPADE Defense Index tripled over the next six years.
When the defense sector is in favor, it can produce significant returns for investors. With rising tensions around the world, investors should keep an eye on this sector.
Interested in learning more about defense sector stocks and what drives it from an investor perspective? SPADE Indexes has produced a free guide for individual and institutional investors. Download for free (and without registration) at: https://www.spadeindex.com/Files/Investing_Defense_Sector_Guide.pdf
The SPADE Defense Index is a passive investment benchmark comprised of publicly traded companies that are systematically important to defense and national/homeland security; and adapts to changes in military strategy, activities, and philosophy. The Index is typically composed of more than 50 firms with products and services that target markets including: naval vessels, military aircraft, armored vehicles, helicopters, drones and remotely piloted vehicles, missiles and missile defense, command and control, networks and Information technology, secure communications, battlespace awareness, intelligence and reconnaissance, and space systems as well as national/homeland security activities including border security, biometric screening systems, and military cybersecurity efforts. Licensed to Invesco, it serves as the underlying index for the Invesco Aerospace and Defense ETF (NYSE: PPA). Additional details on the SPADE Defense Index can be found at www.spadeindex.com/defense
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