History suggests defense stocks will surge in 2022. Will it come to pass?
HomelandDefenseStocks.com Q&A Interview with Scott Sacknoff, SPADE Defense Index
Point Roberts, WA and Delta, BC - January 12, 2022 (Investorideas.com Newswire) Investorideas.com, a global news source and leading investor resource releases an exclusive Q&A interview through its defense portal HomelandDefenseStocks.com.
Scott Sacknoff, manager of the SPADE Defense Index, an investment benchmark for companies involved with the defense, homeland security, aerospace, and government space markets, discusses recent developments in the sector.
Q&A Interview: HomelandDefenseStocks.com (HDS) Scott Sacknoff
With us today is Scott Sacknoff, manager of the SPADE Defense Index, an investment benchmark for companies involved with the defense, homeland security, aerospace, and government space markets and the author of Investing in the Defense Sector, which can be downloaded for free at spadeindex.com/defense.
In this interview we are going to discuss his forecast for 2022 and themes investors should watch for.
InvestorIdeas.com: Investors in defense stocks continue to see their portfolio grow but compared to those investing in the broader market, they have significantly underperformed. Why do you think that is going to change?
Before discussing why 2022 could be the year for defense stocks, it's important to understand the reasons why the prior year was comparatively lackluster. In 2021, the SPADE Defense Index returned more than 7% including dividends. To put that in perspective, it was a down year for defense relative to the broader market but consistent with the historical return for equities.
Over the past couple of years, the attention of most investors, and people in general, centered on the pandemic, and rightly so. Focusing on the disruptions to the economy and the technologies that would enable us to work and interact more remotely proved to be highly profitable. As did investments that tried to time the recovery. However, market gains have been uneven with a few companies driving the broader markets higher. Many investors today are wondering how much growth is left in these stocks. When it came to the defense, since 2020 there were few events to really drive it higher. Additionally, the sector faced headwinds that they might have been able to overcome more rapidly were it not for the pandemic.
InvestorIdeas.com: Can you expand on that please?
Scott Sacknoff: Over the past several years, defense budgets in the United States have remained strong and stable but there was little positive news to provide fuel to the sector after eight consecutive years of returns that beat the market. Right before the pandemic, Boeing was investigating the flight worthiness of its new 737 MAX 8 aircraft following two crashes that put deliveries on hold. Were it not for the pandemic-the review, testing, engineering changes, and approval for the plane to return-to-flight might have happened more quickly. But with a dramatic reduction in the need for commercial air travel and cargo transport due to a slowing global economy-and the key word here is need-the approval stretched on for months. The impact of this was felt hard across the sector as many defense contractors and suppliers participate in the production of aircraft, helicopters, and related vehicles. This led to sporadic supply chain issues and, with Boeing holding off on delivering commercial aircraft, manufacturing activity slowed. The latter half of 2021 saw the return to more normal production levels, the delivery of aircraft, and new orders coming in from airlines. As we begin to emerge, or at least get used to, living life under a pandemic, air travel is making progress toward a return to normal. While still far from pre-pandemic levels, a growing air traffic market will solidify the balance sheets of world's airlines-providing them with the resources needed to modernize and upgrade their air fleets.
One benefit of the pandemic was that nations around the globe were more focused on handling the internal medical and societal issues related to COVID-19 and less interested in border and international conflicts. Or at least, the mainstream media covered these less. Even the pullout of US troops from Afghanistan quickly left the news cycle. But the trade statistics are consistent with it being a quiet period for military action and planning. According to the US State Department, sales of US military equipment to foreign governments during FY20 fell 21% to $138 billion after rising for the past decade.
However, as we venture into the early part of 2022, this is changing. Tensions in areas around the world are beginning to rise. Russia has moved troops to the Ukrainian border and supplied peacekeepers to Kazakhstan. China and the US appear to be expanding their cold war rhetoric and there are rising concerns that 2022 could be the year that China annexes Taiwan. And the stress of pandemic inequalities is seeing increasing unrest in the Middle East as well as social unrest here in the United States. This return to fear and uncertainty is a business environment that should positively and directly impact defense firms, translating into a return of the international sales growth that the sector has seen in recent years. The reaction by France to an announced partnership between the US and the United Kingdom with Australia on submarine development highlights just how important international defense sales are to maintaining a healthy industrial base.
With stable military budgets in the United States, expanding international defense sales, and a return to an expansion phase for commercial aircraft deliveries, we see 2022 being a great year for defense stocks.
InvestorIdeas.com: What does history think of your thesis?
Scott Sacknoff: We've published data on the sector back to 1997 and using this we have identified two previous cycles. In 1998 and 1999, defense stocks underperformed the return of the S&P500 by more than 24%- though it produced a positive return of 23% over those two years. What followed was a nine-year run higher which saw the defense sector outperform the market by several hundred percent. This was followed by a three-year period of underperformance of around 8%-but which saw the SPADE Defense Index gain 30%. This was subsequently followed by 8 consecutive years in which the defense sector gained more than 200%, outperforming the market by more than 70% before the current 2020-2021 underperformance-during which time the index still rose more than 13%.
It's a lot of numbers, but what the pattern says is after a 2-3-year decline, defense stocks have historically come roaring back and produced outsized returns for a number of years. Even during the years that defense stocks underperformed the market, those who invested in a portfolio of aerospace and defense stocks still managed a positive return most of the time. In 19 of the past 25 years, the SPADE Defense Index has been positive-with half the years providing double digit gains. And of the five calendar years that the Index levels declined, three were by less than 3%. Growth while waiting for a reversion to the historical mean has been a winning investment strategy for defense investors in the past.
InvestorIdeas.com: So, what can derail it? What worries you the most?
Scott Sacknoff: There are of course a number of external factors that bear watching. A broad stock market drop due to a declining economy or rising interest rates could pull all securities lower in the short-term. However, over the long term, defense stocks as a whole tend to be less sensitive as (a) its largest customer-government-can literally print new money; (b) defense firms typically maintain low debt ratios, which should protect them from rising interest rates; and (c) many defense contracts come with inflation escalation clauses. As to what would derail the sector over a longer period, the key is political will and whether Congress would reduce spending on defense and security in order to fund new social programs. While a minority in office favor doing just this, they are still just a small minority. Yet, as US politics has revealed, sometimes a minority can direct the agenda and rule. Security and the safety of the nation has importantly, never been out of favor for long.
InvestorIdeas.com: Are you noticing anything in the market that can back up your thesis that defense stocks are set to run higher?
Scott Sacknoff: We've begun to see some uptick in the volume for the Invesco Aerospace and Defense ETF (NYSE: PPA). And looking at the various ETF products in the space, it is interesting that AUM (asset under management) levels have plateaued and been stable at these levels. It is perhaps a sign that everyone who wanted to sell, has done so. The sector is now just waiting for buyers to re-enter.
InvestorIdeas.com: Final Thoughts?
Scott Sacknoff: There are a number of trends that indicate that defense investors are about to rewarded for their patience. In the short-term, of course, the sector could still head lower, but it is my belief that investors have ignored defense in their portfolio for too long.
InvestorIdeas.com: Thank you for taking the time to chat with us. For more information on the SPADE Defense Index, please visit spadeindex.com/defense. To learn more about the Invesco Aerospace and Defense ETF that tracks this benchmark, please visit Invesco's website, the ticker on the NYSE Arca is "PPA".
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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