President Obama’s new military strategy for the U.S. has the potential to ground aerospace and defense exchange traded funds, with the administration proposing hundreds of billions of dollars in spending cuts.
There are several major points against the sector to consider before regarding an aerospace and defense investment at the moment. Elisabeth Bumiller and Thom Shanker for The NY Times report that the withdrawal of a decade of war in Iraq and Afghanistan is important, the fiscal crisis within the U.S. federal budget is also a factor and the rising threat coming from China and Iran are influencing the spending plan for the sector. [Aerospace and Defense ETFs Grounded as Pentagon Faces Cuts]
Another point is the upcoming election and President Obama’s ability to remain in office.
“Conventionally it makes perfect sense to avoid fighting worst-case wars,”Anthony H. Cordesman, a military analyst at the Center for Strategic and International Studies, said. “But the 20th century, even the 21st century, is a reminder to how well anybody can do long-term forecasting.”
The U.S. will be exposed to a strategy that announces American ground forces will no longer be large enough to conduct prolonged, large-scale counterinsurgency campaigns like those in Iraq and Afghanistan. The U.S. army will be cut to 490,000 soldiers from 570,000 over the next 10 years.
On the upside, even if Congress does cut U.S. military spending in half, there is still $300 billion for the nation to spend. Many of the largest aerospace and defense companies have already branched out from a pure U.S. military focus, such as Boeing (NYSE: BA), which has received about 50% of its revenue from the commercial airline business, Aaron Levitt for Investopedia reports. Furthermore, analysts estimate that billions will be spent by both the public and private sector on cyber security. [Dreamliner Puts Aerospace and Defense ETFs in Focus]
The latest sell-off in aerospace and defense shares could be an indicator for some investors to consider value, while enjoying the dividend flow that these giant companies stream. [Budget, Spending Concerns Ground Aerospace and Defense ETFs]
“Many aerospace and defense firms are high-quality firms, with barriers to entry, substantial scale, and duopoly or oligopoly-like characteristics regarding the specific products that they produce. As a result, aerospace and defense companies are able to extract pricing and enjoy economies of scale,” Robert Goldsborough for Morningstar wrote in an ETF analysis.
PowerShares Aerospace and Defense ETF (NYSEArca: PPA) has $55.3 million in assets under management. The fund’s largest holdings include HoneyWell International (NYSE: HON), United Technologies (NYSE: UTX) and Boeing (NYSE: BA). The iShares Dow Jones U.S. Aerospace and Defense Index Fund (NYSEArca: ITA) has $108 billion in assets under management. Top holdings include United Technologies (NYSE: UTX), Boeing (NYSE: BA) and Precision Castparts (NYSE: PCP).
PowerShares Aerospace and Defense ETF
Tisha Guerrero contributed to this article.