Americans are sick of policing the world, and that’s going to crush these stocks

 

As most of my readers remember well, the world changed forever on the morning of September 11, 2001. It is often said that our country has been on a permanent war footing since that day, but that’s less than half of the truth. We have actually been on a permanent war footing since shortly after World War II. What changed is that since September 11, we have been permanently at war. That is why escalation in Syria means less than you might think. Assuming (and it is probably safe to do so) that there is now an increased risk of nuclear annihilation, there’s no way from conventional military contractors to profit from that.

As the possibility increases of a blue wave in November, the risk to the huge future profits of military contractors increases. The likelihood of prolonged conflict may seem to have risen, but in fact, what has really risen is the probability that the US will pull its troops out of the Middle-East. This is easily confirmed by examining the reaction to the recent attack on Syria from both the left and the right. When America’s left and right attempt to pull the government in the same direction, they inevitably get their way.

Absolutely nothing good has happened from the perspective of military contractors, for the risk of a blue wave is now compounded by the risk of rising US isolationism. The next decade will probably be a lot like the cold war of old. Like then, we will have reason to fear a Russian nuclear attack, but unlike then, we will have the technology to make national missile defense practicable. We are headed for a fundamental change of strategy. Americans will soon be more interested in defending themselves than in making the military rich, to borrow a phrase from our president.

Today, we looked at the stocks to sell based on this change. Next week, we’ll look at which ones to buy. I’ll go ahead and declare now that the change seems to be neutral for Lockheed Martin (LMT), which stands to gain from missile defense as it does from any increased risk of military cutbacks, but I’ll also reiterate that Democrats are probably already planning how to spend the money they’ll be cutting from the company’s budget when and if they come to power. Remember to treat these ideas as just that, ideas, and do your own research before making any investment decision.

Huntington Ingalls (HII)

Huntington Ingalls in one of the largest makers of American war ships, a huge expense which won’t seem as needed to a country that plans to pull back and wait to obliterate anything that enters its airspace. As with most military contractors, its share price has been rising rapidly recently, in this case, from $55 to $260 over the past five years. This across the board explosion in the value of military contractors and its unsustainability are going to be among the main themes here today. If you trust current earnings estimates, HII’s valuations are pretty good (t P/E 25, f P/E 15.5), but you only need to look at earnings estimates for a handful of such contractors before you realize that collectively, analysts have already raised their estimates to a level America can’t afford to maintain. Blue wave/isolationism will likely gut this part of the budget.

Chart courtesy of www.stockcharts.com

Teledyne (TDY)

Teledyne is a $7 billion industrial conglomerate that comprises literally 100 internal companies and has an interest in everything from dentistry to aerospace/defense. The company makes a great deal of communications equipment for military vehicles, and is, therefore, very much at risk from rising American isolationism. As shares of TDY have nearly tripled over the past five years, and the current valuations are already high (t P/E 31.25, f P/E 24.55), Teledyne clearly has a lot riding on rapidly expanding military revenue, the prospects for which could be wiped away before the end of the year.

Chart courtesy of www.stockcharts.com

Sell Curtis Wright (CW)

Curtis Wright is another highly diversified supplier. Once the largest supplier of aircraft to the US military, it now mostly produces components, both for aircraft and industrial vehicles. The problem is that it makes components mostly for fixed-wing aircraft, and while they are a huge part of the 2018 budget, they may soon become a much lower priority for the simple reason that they don’t shoot down Russian nukes. CW shares have gone from $31 to $140 over the past five years, and its valuations (t P/E 29.27, f P/E 21.75) suggest confidence that they will continue to draw a larger and larger share of the US budget. Have you spotted the pattern yet?

Chart courtesy of www.stockcharts.com

United Technologies (UTX)

United Technologies, a $100 billion industrial/aerospace/defense conglomerate only makes about 10% of its revenue from the US military, and for that reason, as well as the fact that UTX shares have only risen from $93 to $124 over the past five years, it would have easily avoided today’s list, had it not, back in September, agreed to acquire Rockwell Collins, which is primarily an avionics supplier for $22 billion. With that move, it began to look much more like a military contractor. As a slowly growing company with $27 billion in debt, United Technologies has low valuations (t P/E 21.85, f P/E 15.99). Unfortunately for future shareholders, much current exuberance about future earnings growth is based on the Rockwell Collins acquisition, though Rockwell Collins is as likely as the others to find itself with drastically lowered revenue from the US government.

Chart courtesy of www.stockcharts.com

Symbols: CW HII TDY UTX
Julian Close

Julian Close

Julian Close became a stockbroker in 1995. In his 20 years of market experience, he has seen all market conditions and written about every aspect of investing. Julian has also written extensively on corporate best practices and even written reports for the United Nations. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.

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