Even in a challenging period, publicly traded defense stocks thrive

WAKIL KOHSAR
·4 min read

From a global economic perspective, 2021 will largely be remembered as the bridge between the pandemic disruption of early 2020 and operating in a challenging macroeconomic environment dominated by rising inflation, supply chain issues, the likelihood of a 2022 recession and frequent resurgences of pandemic variants. Companies operating in the defense sector have to navigate these issues as well, but the Russian invasion of Ukraine in February is of critical importance for its stability and will likely remain so for the better part of this decade.

Revenues for Defense News’ Top 100 list increased by 7.9%, rising to $595 billion; the benchmark SPADE Defense Index gained 6.6% for the year. But on the whole, 2021 was a volatile year for publicly traded companies.

The year began with optimism following a weak 2020 marked by the pandemic and the uncertainties of a presidential election year. Backed by a growing defense budget, continued Sino- and Russo-U.S. tensions, and a return to health for the commercial aerospace sector as passenger traffic began to return to pre-pandemic levels, defense stocks surged along with the broader market for the first half of 2021, hitting historic highs for the Index on June 8.

See the Top 100 list here

By midyear, however, some headwinds emerged as the Pentagon withdrawal from Afghanistan delayed some contract awards, and as companies reported the impact of supply chain disruptions. Some firms, such as Lockheed Martin, disappointed investors with guidance that predicted slow growth in the coming year.

As the stock market surged higher, driven by less than a dozen internet and technology firms, the defense sector gave up a portion of its gains — positive returns for the year but underperforming the broader market for the second consecutive year. Individual company returns for the year ranged from greater than 50% gains for Textron, Keysight Technologies and KBR to more than 30% losses in shares prices for Mercury Systems and Telos.

Everything changed in February 2022 with the Russian invasion of Ukraine. Assets invested into defense sector stocks and funds have surged. The Invesco Aerospace and Defense ETF (NYSE: PPA) saw its assets and outstanding shares more than double by June. By midyear, as stock markets around the world crumbled in the face of multidecade-high inflation and the prospects of a recession, the benchmark for publicly traded defense stocks had declined just a few percentage points, offering stability to investors.

As one would expect, Russia’s actions in Ukraine are fueling international growth for the defense industry as nations prepare to protect their borders — particularly NATO and its allies. Security has moved to the front and center of political discussions in many European nations, the U.S. and American allies. Nearly $100 billion in new money was already allocated for equipment and supplies to combat this threat. Additional support is likely.

As 2022 progresses, the defense business environment is faced with a number of changes. In addition to meeting the challenges of wartime production needs, firms in the United States will need to reposition themselves to meet new Pentagon philosophies that aim to build back lost production capacity as well as compensate for crucial component and supply chain disruptions. After a decade of focusing on low-yield precision bombs and missiles used in counterterrorism actions, production of legacy munitions, such as Javelin and Stinger missiles, have suffered. Four months after the invasion of Ukraine began, U.S. stockpiles of these and smart munitions — such as the High Mobility Artillery Rocket System — were severely impacted.

Additionally, announcements of mergers and acquisitions that will impact the Top 100, a staple of prior years, will likely become increasingly rare. A proposed deal for Lockheed Martin to acquire Aerojet Rocketdyne was denied regulatory approval, and a recent Pentagon review of the consolidation of defense industry suppliers expressed concerns.

In total, Defense News’ Top 100 list contains 67 publicly traded companies that represent 72% of the list’s total revenues for 2021. This provides a wealth of data and a measure of transparency for a sector that has shown to be a solid investment in good times as well as troubled ones.

This year, through June 30, 2022, the SPADE Defense Index has declined by just 3.9%, outperforming the broader U.S. stock market, which is down by 20.6%.

Such performance is not atypical: Over the past 21 years, the sector outperformed in 17 of them, many times by double digits. It is one reason why defense sector funds, such as the Invesco Aerospace and Defense ETF, have attracted a collective $6 billion in assets to invest in the sector.

Scott Sacknoff manages the SPADE Defense Index, a modified capitalization-weighted index made up of companies operating in the defense, homeland security and government space sectors.