Defense Stocks Offer Shelter as Tariffs Slam Manufacturers

The recent wave of U.S. tariffs has sent shockwaves through the industrial manufacturing sector, driving up production costs and disrupting supply chains. As companies grapple with the fallout, one sector stands out as a beacon of stability: aerospace and defense. Companies like Lockheed Martin, which specialize in advanced technology systems and products, are seeing increased demand as investors seek safe havens in an uncertain market.

The aerospace and defense sector is partially uncorrelated with the global economy, relying more on government spending and military threats than on consumer demand. This makes it a resilient investment option during economic downturns. For instance, the U.S. President proposed a $750 billion budget for national defense in 2020, a 5% increase from the previous year. This steady revenue stream ensures that defense companies remain profitable even when other sectors struggle.

The recent tariff policies have had a significant impact on various sectors, including the aerospace and defense industry. Companies like Lockheed Martin, which is a global aerospace and defense company, are engaged in the research, design, development, manufacture, integration, and sustainment of advanced technology systems, products, and services. The aerospace and defense sector is partially uncorrelated with the global economy, as its revenues are more dependent on government spending budgets and growing threats of military conflict. For instance, in March 2020, U.S. President Donald Trump proposed $750 billion for national defense in the 2020 federal budget, which represents a $34 billion increase, or about 5%, over what Congress enacted for fiscal year 2019. This indicates a stable revenue stream for companies in this sector, which is less affected by economic downturns compared to other sectors.

In terms of stability and growth potential, the aerospace and defense sector offers a unique advantage. Defensive stocks, such as those in the consumer staples, real estate, and utilities sectors, are typically considered safe havens during times of market uncertainty. However, the aerospace and defense sector has shown resilience and growth potential. For example, the iShares U.S. Aerospace & Defense ETF (ITA) has returned 22.97% year to date (YTD), outperforming the S&P 500 Index by 8% over the same period as of Aug. 7, 2019. This performance highlights the sector's ability to provide both stability and growth, making it an attractive option for investors seeking to mitigate the impact of tariffs and economic uncertainty.

Moreover, the aerospace and defense sector's valuation is competitive. Aerospace and defense components of the S&P 500 trade at roughly 14.9 times estimated 2020 earnings, offering a small discount to the multiple of 15.6 for the average S&P 500 company. This valuation, combined with growing sales visibility through the mid-2020s from a two-year budget deal, makes the sector an appealing investment option. As Morgan Stanley analyst Rajeev Lalwani noted, "We remain constructive on defense stocks and believe they are a good place to be. Growing sales visibility through the mid-2020s from a two-year budget deal pairs well with valuation amid uncertainty." This analysis underscores the sector's potential for stability and growth, even in the face of tariff-related challenges.

The increased demand for defense stocks in the current economic climate is driven by several key factors, primarily stemming from geopolitical tensions and government spending policies.

1. Government Spending and Budget Allocations: One of the primary drivers is the significant increase in government spending on defense. For instance, "U.S. President Donald Trump proposed $750 billion for national defense in the 2020 federal budget, which represents a $34 billion increase, or about 5%, over what Congress enacted for fiscal year 2019." This substantial budget allocation ensures a steady flow of revenue for defense companies, making them less susceptible to economic downturns.

2. Geopolitical Tensions and Military Conflicts: The aerospace and defense sector benefits from growing threats of military conflict. As Rajeev Lalwani, a Morgan Stanley analyst, noted, "Growing sales visibility through the mid-2020s from a two-year budget deal pairs well with valuation amid uncertainty." This visibility is crucial as it provides a stable revenue stream for defense companies, making them attractive investments during times of geopolitical uncertainty.

3. Partial Uncorrelation with the Global Economy: Defense stocks are partially uncorrelated with the global economy, which means they are less affected by economic downturns. This characteristic makes them a safe haven during market volatility. For example, during the 2008 financial crisis, while many stocks plummeted, defensive stocks like those in the healthcare sector showed remarkable resilience. This stability is a significant factor driving the demand for defense stocks.

4. Valuation and Market Performance: From a valuation perspective, aerospace and defense components of the S&P 500 trade at roughly 14.9 times estimated 2020 earnings, offering a small discount to the multiple of 15.6 for the average S&P 500 company. This makes defense stocks an attractive investment option, especially when compared to other sectors that may be overvalued.

In the near future, these factors are likely to evolve in the following ways:

- Continued Government Support: With the proposed budget increases and a two-year budget deal, defense companies can expect continued government support, ensuring stable revenue streams.
- Increasing Geopolitical Tensions: As trade tensions and military conflicts continue to escalate, the demand for defense products and services is likely to remain high, further driving the demand for defense stocks.
- Market Volatility: In an increasingly uncertain global economy, investors are likely to seek out defensive stocks, including those in the aerospace and defense sector, as a safe haven during market volatility.
- Valuation Adjustments: As the market adjusts to new economic realities, defense stocks may continue to offer attractive valuations, making them a compelling investment option for risk-averse investors.



In conclusion, as tariffs continue to disrupt the manufacturing sector, defense stocks like Lockheed Martin offer a stable investment option. With government spending on defense expected to remain high and geopolitical tensions on the rise, the aerospace and defense sector is poised for continued growth. Investors looking to mitigate the impact of tariffs and economic uncertainty would do well to consider adding defense stocks to their portfolios.