Sunday, April 2, 2023
HomeMarketIt’s Not Too Late to Invest in Defense Stocks. These Funds Are...

It’s Not Too Late to Invest in Defense Stocks. These Funds Are Good Plays.

Northrop Grumman’s AN/AAR-47 missile warning system.

- Advertisement -

Courtesy of Northrop Grumman

Russia’s invasion of Ukraine powered aerospace and defense exchange-traded funds to outperform the broader market in 2022, and with the first anniversary coming up on Feb. 24, there’s little evidence that the conflict will end quickly.

The funds received another boost in late December, when the latest U.S. government funding bill earmarked another $47 billion for Ukraine’s defense on top of the $65 billion already appropriated. It also boosted the Pentagon’s budget by 10% for 2023.

The three biggest of the seven aerospace and defense ETFs are positive over the past 12 months, with the $1.8 billion
Invesco Aerospace & Defense
ETF (ticker: PPA) up 15.4%, the $5.4 billion
iShares U.S. Aerospace & Defense
ETF (ITA) up 12%, and the $1.5 billion
SPDR S&P Aerospace & Defense
ETF (XAR) up 8.7%. All are outpacing the
S&P 500 index
and the industrial sector, but if hostilities end in Europe, these highfliers could return to Earth.

“Investors are asking, ‘Is now the time to buy? Did we miss the run-up?’” says Rene Reyna, head of thematic and specialty product strategy at Invesco, relating conversations the firm has had with financial advisor clients. The Invesco ETF saw about $28 million in inflows in January.

Ukraine is a driver of military spending, but the federal budget also earmarks money for potential conflicts, such as between China and Taiwan, says Sheila Kahyaoglu, an analyst covering aerospace and defense at Jefferies. The bank is bullish on the sector. She notes the 10% growth in military spending in the 2023 budget reflects a 5% increase in inflation, so there’s five percentage points of real growth. Additionally, the 2024 budget increases military spending by another 4%.

Bob Smith, president and chief investment officer at Sage Advisory, says that generally, companies in this subsector have solid balance sheets and cash flow, offering reasonable value now, but adds that the ETFs are no longer cheap because of the run-up. “They’re holds now,” he says.

ETF / Ticker 1-Year Total Return 3-Year Total Return AUM (bil) Expense Ratio
iShares U.S. Aerospace & Defense / ITA 12.3% 0.1% $5.4 0.39%
Invesco Aerospace & Defense / PPA 15.4 4.5 1.8 0.58
SPDR S&P Aerospace & Defense / XAR 8.7 1.7 1.5 0.35
Direxion Daily Aerospace & Defense Bull 3X Shares* / DFEN 13.2 -31.6 0.2 0.96
SPDR S&P 500 Trust / SPY -5.7% 9.5% $384.5 0.09%

Note: Returns through Feb. 7; three-year returns are annualized. *ETF uses a leveraged strategy.

Sources: Bloomberg; company reports

Aerospace and defense ETFs are highly concentrated, and what helped to drive the strong returns were heavy bets in military contractors, such as
Northrop Grumman
(NOC) and
Raytheon Technologies
(RTX), which were up 27% and 20%, respectively, in 2022. For the Invesco fund, the two names represent 13% of total holdings, and they are 24% of the iShares fund. Raytheon alone is 20% of the iShares fund and its biggest holding.

Those two stocks represent only a 6.7% combined weight in the S&P fund, which takes a more balanced approach to the subsector. The weighting may explain why the fund lags behind the other two ETFs on a 12-month basis.

The subsector could do well in the short term if there’s a recession, Kahyaoglu says, and Jefferies’ base case is for a hard landing. Brett Manning, a senior market analyst at, says aerospace and defense funds offer investors exposure to the industrial sector in a less cyclical way, with the short-term risk being that if a recession doesn’t occur, the ETFs will underperform cyclical stocks.

Other near-term risks include a House of Representatives that is less likely to agree to further military spending, and high interest rates being a drag on the sector.

Both Manning and Smith are positive on the subsector longer term, citing a potential structural change in global military spending and opportunities in space exploration. Smith says he would be a buyer if the market weakens and the positive longer-term themes remain.

Kahyaoglu says the 2024 military budget increase of 4% will probably need to rise, particularly if Asia-Pacific conflicts come to a head. In addition, sending ordnance to Ukraine exposed “massive” shortfalls in military supply chains. “Especially post-Covid, we need to shore up our manufacturing footprint,” she says.



- Advertisment -

Most Popular