RTX Stock – Investors Shouldn’t Sweat the Defense Budget. Here’s Why.
President Joe Biden is set to offer his first defense budget Friday, though some details are already out. The number for the military looks to be $715 billion—a lot of money, but a tiny increase compared with the roughly $714 billion spent in 2020.
Slow growth tends to have defense hawks crying for more, while doves argue that the money should be spent elsewhere. The latest number, and the debate, might make defense investors nervous, but they have nothing to cry about.
For starters, the $715 billion is pretty good. J.P. Morgan analyst
wrote Friday that the proposal should be well received by the Street. His view is comforting because Wall Street analysts spend a lot of time talking with clients and have a feel for what they expect.
The “White House does not plan to fund its domestic priorities with Defense cuts,” wrote Seifman. “Defense stocks should take the news well.”
Among the largest defense companies, Seifman rates
Northrop Grumman (NOC),
(RTX) at Buy.
Not everyone is as sanguine. Wolfe analyst Michael Mauger downgraded General Dynamics all the way from Buy to Sell without stopping at Hold. He sees risks in connection with the defense budget, but also believes expectations for a commercial aerospace recovery are too optimistic.
Pressure on the defense budget always looms large over the sector, but it doesn’t necessarily translate into weak stock performance. When budget growth stalled out in the 1990s under President Bill Clinton, aerospace and defense stocks barely noticed. The aerospace and defense components of the
returned roughly 18% a year on average during his presidency, outperforming the market by roughly 1 percentage point a year on average.
Valuation helps those returns. Defense stocks are chronically cheap, partly because of budgetary fears. In the 1990s, the sector traded at about a 20% discount to the S&P 500, based on price-to-earnings ratios. Today the discount is closer to 30%.
Worry over how defense budgets will turn out is usually already reflected in stock prices before the numbers land, and the budget generally grows in any case. That is a reasonable basis for solid stock returns.
Of course, defense-sector stock returns in any year will be determined by a host of factors, including global conflict and new defense programs, as well as the overall budget. Traders can have fun with those data points.
Investors shouldn’t sweat the budget all that much, though. Over the long run, the budget tends to keep up with inflation, providing defense contractors with plenty of opportunity.
Barron’s recently recommended stock in
(LMT). We believe the commercial space business is a new opportunity, but also like the company’s positioning in the defense industry. That article only appeared a few weeks ago, but Lockheed stock is up about 9% since then.
Write to Al Root at [email protected]