There’s an old saying, almost trite: The best defense is a good offense.
Well, maybe they got it wrong. Maybe the best offense is a good defense, as
in a defense stock or two.
With the Bush administration’s pro-defense bent, and firm backing of a strong anti missile system, defense and aerospace stocks are looking brighter these days, after years of funding neglect by the federal government and heavy doubting by investors.
Last year, a dismal year for the stock market overall, the S&P 500 Index fell 9.2%, but its defense component shot up more than 57%.
“Everybody thought I was nuts to get into these stocks, but we’ve proved them wrong,” says Paul Houk, portfolio manager of SG Cowen Income + Growth {COIGX }, whose 43% gain last year was the highest in the equity income category, according to Lipper Inc.
Houk’s fund and other diversified equity funds like Prudential Jennison Equity Opportunity {TJIAX} and pure play Fidelity Select Defense and Aerospace {FSDAX}, are betting on defense. Given the administration’s defense bias, they are promising, assuming Bush & Co. gets congressional approval for their defense program.
Defense
stocks that fund managers find intriguing include most of the biggies –
Raytheon
{RTN.B, News, Boards}, Northrup Grumman {NOC, News,
Boards}, Lockheed Martin {LMT, News, Boards}, the
world’s largest defense contractor, Boeing {BA, News, Boards},
and Litton Industries {LIT, News, Boards}, among others.
Over the past decade, a wave of consolidation has swallowed up many of the smaller players. One recent example is Litton Industries, which is being acquired by Northrop Grumman.
Some pros lump General Dynamics {GD, News, Boards} and shipbuilder Newport New {NNS, News, Boards} in the defense mix as well. Another favorite is Boeing, which through heavily exposed to commercial aviation, is a key beneficiary of increased defense spending.
For fund investors, the only pure play is Fidelity Select Defense and Aerospace {FSDAX}. It’s had lackluster returns over the last few years, but in 2000 the fund shot the lights out with a return of 18.92%. It counts General Dynamics, Rockwell International {ROK, News, Boards}, General Electric {GE, News, Boards}, and Lockheed Martin among its top 10 holdings.
Morton Siegel, assistant research director at Value Line Inc., has followed the sector over two decades. Some stocks like Northrop Grumman have done real well recently, but he believes there’s still room for future growth.
“It looks to me like Mr. Bush is going to spend considerably more money on the various aspects of defense. The missile defense system is just one item,” says Siegel.
The outlook was different after the Gulf War of 1990-91. Defense spending was put on the back burner in Washington while domestic issues took precedence.
Houk has an 11.5% position in the sector – a huge overweighting compared to the S&P’s 2%. He owns Raytheon, Lockheed Martin and Northrop Grumman, all of which he purchased in the first quarter of last year. While the stocks have doubled since then, Houk believes they have a further 50% to 100% upside from here.
He agrees with Siegel that these firms will be direct beneficiaries of increased government spending.
Meanwhile, Brian Gillott, co-manager of Prudential Jennison Equity Opportunity, a multi-cap value fund that looks at all sectors, estimates that his defense holdings including Boeing, Raytheon and Litton Industries, added about five percentage points to his 32% return last year.
“Because we bought them in the spring near their lows and they’ve rebounded up to 50% from that level, they’ve contributed a lot to our performance,” he notes. The fund is up 4.5% through Feb. 27.
Why the turnaround in these stocks? In a word, tech’s loss has been defense’s gain, according to the fund pros. While the “tech wreck” of last spring wreaked havoc in technology stocks, investors shifted their attention elsewhere and began concentrating on other sectors like defense.
While the Nasdaq Composite was sliced in half last year, defense stocks more than doubled in price.
It looks
like Big Defense is returning with a bang.