Possible Opportunities In Defense Stocks

• February 24, 2003
• Edward Allen

Although defense
stocks will likely benefit from increased
defense spending over the longer term, they are currently suffering despite an
almost certain war with Iraq. This can be attributed to the fact that many
investors, believing that this war will be similar to those of the twentieth
century, enthusiastically buy up these stocks on the first sign of tension
(creating a bubble). However, this conflict is likely to be shorter in duration
and won’t require the sustained heavy bombing campaigns that have been used in
the past. As a result, there will be less demand for weapons development and
production.

Why this conflict is different

• Most of Iraq’s defense capabilities were
  either destroyed during the Gulf War or during subsequent precision bombings
  by the US and UK, as they have enforced the no fly zones. The initial bombing
  campaign will be much shorter than previous ones and will likely used to
  create fear and confusion among the Iraqi troops.

   

• The Allies will be reluctant to inflict any
  more serious damage to Iraq’s infrastructure for two reasons: 

a) The allies will have to rebuild Iraq this
time around.

b) After the war is over, the allies will have to occupy Iraq and maintain law
and order. Thus, they are reluctant to anger the civilian population that they
will be governing.

• The actual conflict will likely involve more
  light munitions and actual troop combat than the massive bombing campaigns in
  previous wars. Why?    

  a) Intelligence
  reports suggest that Saddam will adopt an “Iron Triangle” defensive strategy
  around heavily populated Baghdad. And in order to avoid heavy
  civilian casualties, the allies will rely less on bombs and more on troops.
  Also, in order to secure the many oil fields–very important–the allies will 
  have to use combat troops instead of heavy bombing and
  artillery.               

Defense stocks are a better
long-term play

Defense stocks are likely to benefit over the
longer term as defense spending is expected to increase by 4% a year–reaching
over $400 billion dollars in four years. Government appropriations for defense
spending has not been that high since peaking in the eighties. As a result,
investors will be better served by gradually scaling into defense stocks, such
as General Dynamics
(
GD |
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News |
PowerRating) and Northrop Grumman
(
NOC |
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PowerRating).

Consider the current bullish MACD histogram
divergence developing. This may offer an opportunity to scale into a longer-term
defense play.

Edward Allen