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Big Opportunities Still Exist In The Aerospace & Defense Sector

From Invesco: A potential increase in defense spending and an uptick in commercial aircraft orders could boost the aerospace & defense industry’s prospects.

The defense industry has been a strong performer since the Nov. 8 US elections. Between Nov. 8, 2016, and Feb. 24, 2017, the SPADE Defense Index has rallied 14.54% — outpacing the S&P 500 Index by more than 3%.1 Given the scale of the Trump administration’s proposed defense budget, as well as positive trends in commercial airline orders, I believe prospects are favorable for aerospace and defense firms.

US aerospace and defense orders are rising

After showing flat to declining growth since 2010, US defense orders — which include aircraft, related parts and other military hardware produced by the Department of Defense — have been trending upward and are now approaching 2010 highs as a result of revitalized defense spending that began under President Obama and looks to increase even more under President Trump. The president’s recently unveiled budget proposal calls for a 10% ($54 billion) increase in military spending, which is likely to be well-received by many members of the GOP-led Congress.

Non-defense aircraft orders have seen similar patterns. After a choppy few years, six-month average aircraft order volume tailed off through the first half of 2016, but has advanced since then. These trends can be seen in the chart below.

Non-defense aircraft orders

Source: Bloomberg L.P., as of Feb. 27, 2017

Commercial airline orders could bode well for profits

Non-defense aircraft orders are important, as defense contractors such as Boeing, United Technologies and Honeywell profit by selling goods and services to commercial aviation firms. (As of Feb. 28, 2017, these companies represented 7.52%, 6.70% and 7.00%, respectively, of the PowerShares Aerospace & Defense Portfolio.)

In its January earnings call, Boeing executives indicated that they view aviation as a long-term growth industry, and that Boeing is seeing healthy passenger traffic and a modestly improving air cargo market — conditions that are constructive for aircraft production.2 If aircraft manufacturers manage order volume efficiently, the upward trend in commercial aircraft demand could flow through to the bottom line in the form of healthy profit growth.

Global defense spending could rise as well

The Trump administration has suggested that European member nations of the North Atlantic Treaty Organization (NATO) should contribute more to defense spending. The chart below shows what NATO members currently contribute as a percentage of gross domestic product. In my view, it would not be surprising to see an uptick in some of these numbers as a direct result of pressure from the US.

What NATO members currently contribute as a percentage of gross domestic product

Source: North Atlantic Treaty Organization as of July 2016

Outside of NATO, Saudi Arabia is expected to boost its defense budget by 6.6% in 2017, according to defense data provider IHS Jane’s.3 And Reuters recently highlighted high levels of defense spending in the Gulf States of the Middle East — despite weak oil prices.4

Defense budgets are increasing in Asia as well. In December 2016, IHS Jane’s projected continued growth in China’s defense spending, with total outlays expected to reach $233 billion by 2020 — up from $123 billion in 2010.3

What does this mean for investors?

The prospect of increased US and global defense spending, overlaid with positive trends in commercial aircraft, creates a backdrop that could be favorable for aerospace and defense firms. I believe that now may be the right time to give these companies a closer look.

Investors interested in the aerospace and defense industries may wish to consider the PowerShares Aerospace & Defense Portfolio (PPA).

The PowerShares Aerospace & Defense ETF (NYSE:PPA) was unchanged in premarket trading Thursday. Year-to-date, PPA has gained 5.56%, versus a 5.83% rise in the benchmark S&P 500 index during the same period.

PPA currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #12 of 34 ETFs in the Industrials Equities ETFs category.

1 Source: Bloomberg L.P., Feb. 24, 2017
2 Source: Boeing, Jan. 25, 2017
3 Source: IHS Jane’s, Dec. 28, 2016
4 Source: Reuters, Feb. 18, 2017

Important information

The SPADE Defense Index is a modified capitalization-weighted index composed of publicly traded companies that benchmarks the performance of companies involved with defense, homeland security and space.

An investment cannot be made in an index.

Past performance is no guarantee of future results.

PowerShares Aerospace & Defense Portfolio risks

There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. The fund’s return may not match the return of the underlying index. The fund is subject to certain other risks. Please see the current prospectus for more information regarding the risk associated with an investment in the fund.

Investments focused in a particular industry, such as aerospace and defense, are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments.

Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.

The fund is nondiversified and may experience greater volatility than a more diversified investment.

This article is brought to you courtesy of Invesco.

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