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Dryden Pence’s Outlook For Defense Sector

Dryden Pence, Chief Investment Officer of Pence Capital Management, looks to the defense sector and says it has reasonable valuations and dividend yields. He says that defense spending as a share of GDP is near historical lows and the U.S. defense budget is 21% higher that 4 years ago. 

March 3, 2021

Dryden Pence, Chief Investment Officer at Pence Capital Management, is here to join us to explain why you may want to consider the defense sector as an opportunity within your portfolio. Is this for everybody? What are you looking at here in the defense sector? 

Certainly, with the volatility that we have in the market and everything that’s going on, some people are trying to be a bit more defensive. If they are, then that’s probably a good place to look because companies that have good, solid long-term earning potential or revenue streams that are well-planned out or stable tend to be able to have some stabilized earnings.

So if you feel like things are a little volatile, now the market’s a little toppy, there are things that you worry about—if you want to begin to be defensive, you don’t necessarily have to run to the bond market, but you can change your portfolio a bit to where the holdings within it are a little less volatile or a little more assured than some of the high-flying names that we’ve seen lately. That’s kind of the whole thought about being defensive with your defense selections.

I was looking at your chart detailing defense spending as a share of GDP, as well as a quote from the House Armed Services Committee talking about funding. We had $741 billion last October for defense; they did not see an increase to the defense budget. That being said, names like Northrop Grumman, Lockheed Martinthese are fantastic companies, national security. I couldn’t believe in these companies more, but is now the time to invest?

I think the thing you pay attention to is when you think about our defense budget—although it’s very big—it’s 3% of GDP. It’s actually falling as a percentage of GDP. As our economy grows, the defense budget held stable at $741 billion. It’s still tremendously large. We don’t know about this $1.9 trillion stimulus package, but what we do know is that the NDAA —National Defense Authorization Act—passed with bipartisan support and overrode a veto to get there. The point is you’ve got a very stable funding mechanism.

The two companies you’ve talked about—you’ve got Northrup Grumman, they’ve got about an $81 million backlog with the B-21 bomber and Lockheed Martin with the F-35—about a $147 billion backlog. The administrative risk on these things, or the administration and political risk of these things, has pretty much ameliorated. The revenue streams are pretty understood. The order book is pretty understood. All of those variables that are creating volatility or worry about the market are really not as prominent in these companies that pay decent dividends and can continue throughout this volatile period. When you look at a 3% GDP for our defense as a stabilized number over time, it’s a lot of money, and these companies are key providers of the equipment that we need.

It’s interesting how it’s just sort of trended lower. I look at this chart, I see the trend lower and lowerthe defense spending as a share of GDP. Listen, I am not a historian. I look at stocks more than I do world history, Dryden, but I would say there’s room to the upside.

When you look at defense spending as a percentage of GDP, again, as the chart shows, it’s coming down. Thus, the political argument about cutting defense spending becomes less and less important. When you’re in an environment where now you’re having some global risks put back in the portfolio—we had issues in Syria and Iran, for example—it’s highly sustainable. The companies involved in this seem to be in a position where they can be quite profitable with a strong order book at that sustained level of purchasing and the industry as well.

Isn’t that a good point to make, Dryden?

Absolutely. Lockheed pays at 3.1; both of them basically pay higher than the average SMP. Both of them are paying higher than a treasury. So you’ve got a lot of stability dividend to boot.

Great to see you, Dryden Pence, Chief Investment Officer, Pence Capital Management.

The opinions expressed are for general information purposes only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making any decision.

All performance referenced is historical and is no guarantee of future results. All indices referenced, if any, are unmanaged and may not be invested into directly.

The opinions expressed in this material are those of Pence Capital Management and do not necessarily reflect the views of LPL Financial.

Third party comments made within this communication do not reflect the views of LPL Financial and have not been reviewed by LPL Financial as to accuracy or completeness.

Dividend payments are not guaranteed and may be reduced or eliminated at any time by the company.

Securities and Advisory Services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC. TD Ameritrade Network, Pence Capital Management and LPL Financial are separate entities.

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