As analysts and the market try to sort out how the new division in Congress will play out in markets, one beneficiary is becoming increasingly clear. Aerospace analyst Ron Epstein of Merrill Lynch had this to say the day before last week’s election, “The change to Democratic control of the House is the best scenario for defense spending. It points to upside in the defense budget. Gridlock keeps budgets intact, and defense is a bipartisan issue”. That argument is a bedrock of the new view that defense stocks are likely going to surge in the new Congressional environment. Epstein points out that aerospace companies are simultaneously seeing commercial and defense businesses growing strongly.
FINSUM: Earnings seem like they will stay in very good shape for the defense sector, and because budget changes look unlikely, the whole industry seems to be in for smooth sailing.
Trump is away for the week, traveling to meet with leaders of other countries. However, when he returns home, he will ask Congress to approve $3.6 tn of spending cuts as part of his proposed budget. Military, social security, and Medicare will be sheltered from the budget guillotine, but anti-poverty programs will be gutted. The proposals are facing resistance on both sides, with Democrats thoroughly opposed and even Republicans disliking the cuts to diplomacy and foreign aid. Trump’s hopes the plan will eliminate the federal deficit within a decade, but economists doubt his baseline 3% growth rate assumption.
FINSUM: To say this is a big ask of Congress is the understatement of the century. However, the tactic is classic Trump—ask for the world at the beginning and then give ground. We think some toned down package will eventually get through.
Source: Financial Times
Whether or not you think Trump will win, this is an interesting article, as it chooses two stocks to buy, either as hedging, or to proactively try to profit from a Trump triumph. The picks come from Credit Suisse. Trump has promised to boost defense spending and compel allies to do the same, so the two picks are defense stocks Raytheon Co. and Thales SA. Trump has said that under his presidency the US’ continuing support for NATO would become contingent upon members boosting defense spending to 2% of GDP, which only two European countries currently do, which CS says makes the two stocks a “clear overweight”.
FINSUM: As this piece says, shorting the Mexican Peso—the former go-to trade to play a Trump election— just got less attractive because of a rate hike there, so this piece is well-timed.
The Wall Street Journal has published an article which looks at certain sector ETFs and how they might respond to market turmoil. The piece highlights on Aerospace and Defense-focused ETFs and says that many analysts say they have a lot to offer, despite the fact that the have taken “flak” in recent months. There are three ETFs focused on the space, from BlackRock, Invesco, and SPDR, and they have had mixed performance so far this year. However, the argument for them is that the world’s geopolitical tensions are not improving and that sentiment for increased military spending in the US is rising. According to a director of ETF research at Zacks, “The sentiment for aerospace and defense stocks is improving with rising geopolitical tensions”. All that said, the sector is potentially being hurt by a stronger Dollar, a weakening Chinese economy, and lower energy prices (some of the companies make equipment for the sector).
FINSUM: This is an interesting argument, which is part of a more alarming rise in global tensions.
Source: Wall Street Journal
Continuing their highly politicised push to stop corporate tax inversions and shame companies who do so, Democrats from both chambers of Congress yesterday announced a new plan to cut government contracts to any company who relocated overseas. The US government already has rules that no federal contract shall be awarded to a company who relocates overseas with at least 80% US-based shareholders, but Democrats want the bar lowered to 50%, which would prove a major drawback for any company planning a move. Republicans lashed out at the Democrats for the measure, and are in favour of a major overhaul instead of any stopgap changes. Pfizer, who attempted the largest inversion in history when it tried to buy AstraZeneca in May, went on the record yesterday saying it favoured an overhaul of the US tax system, but that it would not be inhibited in moving overseas, announcing that it was still actively trying to do so.
FINSUM: Because most of the inversions have been in the healthcare industry, which relies very little on direct government contracts, this new measure would likely have little effect. However, rumour has it that a number of defence contractors were planning moves, so this is clearly a threat to them.