As you grapple with a volatile stock market and attempt to position your portfolio for 2024, consider the investment profits available in what President Dwight Eisenhower famously called “the military-industrial complex.”
Global defense spending in 2023 reached a jaw-dropping $2.2 trillion, the highest level in inflation-adjusted dollars since the end of the Cold War in 1991, according to the latest data from the Stockholm Research Peace Institute, which compiles a tally every year. As of last year, the U.S. shipped 45% of the world’s weapons exports, roughly five times more than any other nation.
The Israel/Hamas and Russia-Ukraine wars, and worsening antagonism among the U.S., Russia and China, have fueled a push in Washington to boost Pentagon funding even further. Therein lays an investment megatrend for 2024 and beyond.
Orders now pouring into the coffers of U.S.-based aerospace/defense contractors will generate lucrative work for years, posing a bonanza for investors with exposure to the sector. As I’ll explain below, defense stocks also make superb inflation hedges and they’re recession-resistant.
Weapons of mass wealth…
A key driver of the boom in defense spending is the increasing purchase of complex new weapons systems. Excluding sales within the U.S., China, and Russia, procurement of these systems is projected to reach $241 billion next year, a 23% increase since 2022, even after adjusting for inflation.
U.S. defense spending already hovers at gargantuan levels. If you ever hear an American politician complain that the country’s military is being underfunded and neglected, well, that argument is sheer demagoguery. The Pentagon never has to rattle a tin cup.
Defense spending is one of the few items that enjoys bipartisan support on Capitol Hill; Pentagon funding has been rising under Biden’s presidency. Spending on procurement climbed dramatically in FY2023, including a 55% boost for U.S. Army funding to buy new tactical missiles to replace the ones given to Ukraine.
In a national address last Friday, President Biden laid out the details of a $105 billion package that includes military assistance for the conflicts in Ukraine and Israel.
The war in Ukraine has used up vast amounts of the U.S. stockpile of weapons, especially missiles, and the Pentagon is scrambling to make up for the shortfall. The White House also has been increasing military assistance to the democratic island of Taiwan, which is increasingly threatened by adjacent mainland China.
Funding levels that rival WWII…
Eisenhower coined the term military-industrial complex during his farewell address in 1960, to warn Americans that defense spending was gobbling up a disproportionate share of the nation’s resources.
Before he was Commander-in-Chief, Eisenhower was the Supreme Allied Commander of the Allied Expeditionary Force during World War II, and he supervised D-Day.
Ike knew a thing or two about the military, and he probably would have blanched at this fact: The U.S. military budget for FY2023 is the second highest in U.S. history, in inflation-adjusted returns. Only during WWII did the budget reach higher levels. (Let that fact sink in.)
The fiscal year 2023 Defense Appropriations bill provides $797.6 billion, an increase of $69.2 billion over FY22. Defense funding for FY2023 represents a level that’s more than the budgets for the next 10 largest cabinet agencies combined. The FY24 defense budget provides even more in total funding, at $831.781 billion.
But it’s not just America. Military budgets around the world are burgeoning, especially as NATO countries ramp up to defend themselves against Russia’s revanchism. Germany, in particular, is set to significantly increase defense spending for next year. Even Japan, which has been pacifist since its defeat in 1945, is hiking defense spending in response to China’s saber-rattling in the Asia-Pacific.
If you’re looking for a source of profits that enjoys multi-year momentum, the aerospace/defense sector fits the bill. Pentagon suppliers get a steady stream of contracts, courtesy of taxpayers, regardless of economic cycles, the movement of inflation and interest rates, the political party in power, or monetary policy.
Uncertainties caused by geopolitical conflict or deadly pandemics only prompt governments to increase defense budgets.
Aerospace/defense is not only a growth proposition, it’s also a hedge against inflation and risk. “Cost-plus” contracts allow military contractors to include higher input costs into what they eventually charge the Pentagon. Not all defense contracts are cost-plus, but many are, and even contracts that aren’t often feature some protection from inflation.
Take a look at the following chart. The benchmark SPDR S&P Aerospace & Defense ETF (XAR) is on the brink of breaking through its 50- and 200-day moving averages. The exchange-traded fund is showing upward momentum, despite the broader market’s slump (data as of market close October 23):
Don’t get me wrong. War is a horrible thing. We should pray that one day, all countries beat their swords into plowshares. But if history is any guide, wars will continue to happen. And that’s why aerospace/defense is one of the most enduring investment themes you can find.
Geopolitical risks are likely to increase in 2024, as conflicts in the Middle East and Eastern Europe drag on. At the same time, Russia, China, North Korea and other antagonists of America continue to test the resolve of the Biden administration. The best opportunities are the handful of U.S.-based aerospace/defense firms that dominate global defense spending.
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