In February this year, investors’ focus changed from health to war when Vladimir Putin’s Russia launched a full-scale ground invasion of its western-flanked neighbor, Ukraine.
Suddenly the COVID panic took a back seat to other more pertinent events, as the global hive-mind now arraigned itself in unison to sport blue-and-yellow Prapor Ukrainy flags, looking on in awe as former comedian-turned-politician, Volodymyr Zelenskyy, undertook his own version of shuttle diplomacy, trying to cajole supposed allies – such as Britain, Germany and the United States – to go to war with the nuclear-armed successor of the former United Socialist Soviet Republic.
As the battle in the region raged on, attention inevitably shifted to how the conflict would develop in the near-term, how the invasion would eventually deescalate, and what a post-war Ukraine and the surrounding territories would ultimately come to look like.
Some of the key players that will determine what happens to Ukraine in the future are those companies that collectively make up the leviathan that is the defense industry.
These companies are responsible for producing a wide range of products, including:
- fighter jets,
- battle ships,
- combat vehicles,
- weaponry,
- developing intelligence systems,
- cybersecurity defenses,
- robotics; and
- military electronics.
With the financial locus appearing to switch from what is an old pandemic to a newly-minted war, let’s examine the prospects for defense stocks in the coming, turbulent years.
Source: Unsplash
Will Defense Stocks Benefit As Global Tensions Rise?
The events unfolding in Eastern Europe are just the latest phase in the ongoing Russo-Ukrainian War, which began in 2014 after Russia annexed the Crimean Peninsula in response to the overthrow of the then democratically-elected president of Ukraine, Viktor Yanukovych.
Further fighting erupted between Russian-backed separatists and Ukrainian forces in and around the Donbass region, where hostilities continue there to this day.
This recent escalation between the two countries has certainly had an effect on the price of some of the biggest defense firms on the market. For instance, Northrop Grumman and Lockheed Martin are both up more than 16% the last month, which is around double that of the S&P 500.
Whether the Ukrainian conflict continues to be a tailwind for the sector remains to be seen, but there are other reasons to be bullish for defense stocks this year.
To begin with, the war in Europe isn’t the only actual or potential flash-point around the world right now. In fact, there are numerous geopolitical and economic conflicts that are just waiting for a spark to set them off.
For example, China has been especially vocal lately about its claims on the island of Taiwan – a situation which holds many disturbing parallels to the Russian invasion of Ukraine.
Furthermore, Russia might not settle with just one invasion of a neighboring country – the recent failed coup attempt in Kazakhstan has shades of the Euromaidan revolt that presaged the expulsion of Yanukovych eight years ago, and Putin won’t want to let that situation gather any more momentum than is strictly tolerable.
And it’s not just “hot” wars that could see defense companies make gains in the current climate. Tensions are being ratcheted-up all around the world, from North Korea’s nuclear provocations, to uncertainties surrounding the exit of US forces from Afghanistan and Iraq.
There’s even the threat of civil unrest in America too, as the culture wars migrate from the editorial columns of the Washington Post and New York Times, and into the very real world of ordinary people’s lives. The rise of cyberwarfare too – whether coordinated between state or non-state actors – is also a growing problem, and one which will only get worse as time goes on.
However, defense projects tend to be multi-year affairs, and the vagaries of current events don’t normally impact investor sentiment as much as you might think. While there will probably be a boost to sales of certain kinds of materiel, it probably won’t be enough to move the needle on individual share prices to any significant degree.
In fact, defense companies often see better margins on contracts that are concerned with the development of new technologies than they do on the sale on preexisting products. Indeed, if the US government shifts its funding from research and development to emphasize spending on ongoing conflicts, the industry might actually perform worse rather than better.
All that said, the shock to the system that Russia’s actions in Ukraine inflicted on America and its NATO allies is a stark reminder of how important a well-equipped fighting force is in the present day. This realization is sure to drive investment into the defense sector, which is good news for the companies that make and sustain the hardware and software that a modern army runs on.
How To Invest In Defense Stocks
Companies operating in the defense sector tick many of the boxes that investors look for in a good business. Because the bulk of money that flows into the industry comes from the US government, they are able to produce reliable and predictable revenues, especially since many of the contracts involved are planned purchases that have been years in the making. Furthermore, this stability often means that defense companies can issue safe, high yielding dividend payments too.
So, what’s the best way to gain exposure to the defense industry at the present time?
Well, there are two broad approaches to this. The first approach is to invest in individual stocks, maximizing any upside from your position, but making you liable for the business risk that the associated company takes on.
Alternatively, the second would be to invest in something like an exchange-traded fund (ETF), which minimizes your risk profile, but wouldn’t gain as much from one company performing exceptionally well.
For those interested in the first approach, a company such as Raytheon Technologies might make for a good pick. The firm is a big hitter in the sector, with a market cap of $150 billion, free cash flow of $5 billion, and a year-on-year revenue increase of 13.8%. However, the business really makes the case for investor interest when you consider its excellent dividend, which it’s been increasing for 28 consecutive years now.
If you’re naturally a little bit more risk averse, then you might prefer a fund like the Invesco Aerospace & Defense ETF, which tracks the more than 50 companies that comprise the SPADE™ Defense Index. The fund is well weighted too, with its top holding, Lockheed Martin, only accounting for 7.42% of the ETF.
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