When you live near Washington, as I do, the military is never far from your mind. As I mentioned in this post, Fort Washington, which failed to defend the area in 1812, was not far from my home when I was growing up. You can’t drive down any street in Northern Virginia without running into a historical marker about the Civil War. The Pentagon, Arlington National Cemetery and the World War II Memorial are an easy drive from here.
Back in July 2015, I noted that defense stocks seemed like a decent investment idea, given the enormous amounts of money the nation spends on the military — currently $619 billion. I’m happy to report that the two aerospace & defense ETFs mentioned in the post, iShares US Aerospace & Defense (ITA) and SPDR Aerospace & Defense (XAR), have risen at an annualized 13.94% and 11.14%, respectively, since I published the post. The Standard & Poor’s 500 stock index has risen at a 6.92% pace.
Before I do a victory lap in a shiny new F-35, however, I should note that timing is everything. Before the election, SPDR Aerospace & Defense (XAR) lagged the S&P 500, rising at a 2.11% pace, vs. 3.32% for the S&P. iShares US Aerospace & Defense (ITA) faredm s0mewhat better, gaining 6.05%.
The stocks have popped because of the incoming administration’s pledge to increase military spending. Betting on what any administration can and will accomplish is, of course, a risky bet. Congress isn’t in a particularly spend-y mood, even given the election results. And judging from Mr. Trump’s objections to the cost of a new Air Force One (actually two, and it’s only Air Force One when the president is in it), some penny-pinching may be in the future for defense as well as the rest of government.
At least a fairly major increase in military spending has already been built into defense stocks. The iShares offering now sells for 21.56 times its past 12 months’ earnings, while the SPDR fund sells for 22.37. (The latter fund tends to have more small-cap stocks). The S&P 500 is at 19.86 times earnings, which is well above its average of about 16.
Could they go higher? Sure. Americans don’t object to defense spending the way they do to social spending. And everyone seems to remember that the massive spending in World War II helped push the nation out of the Great Depression. (This was a massive government spending program that we still haven’t paid off, but never mind.)
Bear in mind, however, that you need two conditions to make a profitable war. First, of course, you have to win it. (Ask Germany and Japan). Second, it’s best not to fight it on your own ground. (Ask France.) The best use for a cannon is not to use it at all.