The defense sector has been one of the stable and strongest growing sectors since the 9/11 attacks. Firms in this sector were the biggest beneficiaries of rising defense budgets especially in the US. For example, Lockheed Martin (LMT) is up about 46% year-to-date. Despite excellent performance in the past, a recent journal article cautions investors on this industry. From the WSJ article:

Investors in defense companies have spent years uncorking Champagne bottles because the world couldn’t be going any better for them. But that may be their biggest problem as well.

Defense shares have returned 130% since 2014—based on a constructed index of 25 firms—compared with 89% for the S&P 500. This year has been particularly buoyant because investors were eager to buy stocks but also hedge against a slowing economy, so they piled into “safe” income-paying assets.

Military contractors have also ridden the coattails of unprecedented Congressional defense spending, which has pushed net-profit margins to records. This is part of a broad effort to retire the last Cold War defense technology in favor of a new generation of weapons such as hypersonics—an area where China and Russia are racing ahead.

The deck appears stacked in their favor: U.S. military spending is set to rise for a fifth consecutive year to a near-record $738 billion, the number of bidders for government contracts keeps shrinking, and geopolitical tensions are mounting—including escalating tension with North Korea over the country’s nuclear program and with Iran over alleged attacks on oil tankers.

Under the surface of all these astronomical numbers, however, there may be too many assumptions baked in by investors.

Political spats involving defense are escalating ahead of next year’s presidential election. Some voices within the Democratic Party argue for military spending to be slashed, including presidential candidate Sen. Elizabeth Warren. While most Democratic lawmakers don’t plan to follow, it is now likely that Congress won’t agree on a full defense bill before year-end for the first time in 58 years amid controversy over such projects as Mr. Trump’s border wall and new nuclear weapons.

Source: How Long Can the Defense Party Last?, WSJ, Nov 9-10, 2019

The Top 10 Defense Companies in the world for 2019 are shown in the graphic below:

Click to enlarge

Source: Defense News

Some of the major US-based defense firms are:

• Lockheed Martin (LMT)
• General Dynamics (GD)
• Boeing (BA)
• Northrop Grumman (NOC)
• Raytheon (RTN)

The SPDR S&P Aerospace & Defense ETF (XAR) has soared 39% compared to S&P 500’s return of 23% year-to-date:

Source: Yahoo Finance

Takeaway:

Investors looking to add defense stocks may want to wait for pullbacks. Even if you have to deploy some cash soon it is wise to add in a phased manner.

Related:

• Why Invest in European Aerospace & Defense Stocks, TFS
• 11 Defense Numbers to Consider on Veterans Day, Barrons, Nov 11, 2019

Disclosure: No Positions

Tech stocks are hot again this year. The top flying stocks are up by double digits percentage points year-to-date. The bull market in this sector continues for the past few years. Seemingly endless growth and innovation are driving investors to pay sky-high premiums for the top tech market darlings such as the FAANGs. Some of these firms are not exactly coming up with innovative products but rather adding new features or slightly tweaking existing products in order to provide an aura of ground breaking innovation. One company that follows this “strategy” is Apple(AAPL). Recently the firm add yet another camera to its flagship product iPhone claiming this is some of innovation and pricing it accordingly. Apple also added noise cancellation technology to its Airpods and named its Airpod Pro with a 50%+ increase in price. Obviously this sort of innovation is dubious at best. Apple simply expects customers will shell out an extra $100 or so for this feature. While airpods may be popular they are not really practical at all and are prone to getting lost easily Because they are so tiny many customers have lost them. So asking customers to pay more for the same product but with some new gimmick is probably a tough sell.

Other firms such as Facebook(FB) and Alphabet, parent of Google (GOOG) are also not exactly innovative firms anymore. Facebook in a true sense is a giant mess and is primarily an advertising company and extracting time and attention from people with time on their hands. Obviously it is not considered an ad company but rather a silicon valley giant. Wallstreet values Facebook as a tech company. Similarly lately Google has become another huge ad platform. Though the company is primarily in the search engine business, it is morphing into another ad platform.

With that said, some investors may be wondering is it really different this time compared to the past NASDAQ collapse?  The following chart shows the YTD price returns of the FAANGs:

Click to enlarge

Note: Data shown above is as of Nov 1, 2019

Source: Yahoo Finance

I came across an interesting article on this topic recently at Money Observer. From the piece:

Is Amazon, for example, a technology company, a cloud computing infrastructure provider or a retailer?

Rise and fall of the Nasdaq
-gained 358% Jan 1998 to March 2000

Learning from history

Similar questions arose as the dotcom era gathered momentum. The likes of Boo.com and Pets.com were retailers using the internet as a distribution channel, but they were considered to be tech stocks and their valuations reflected that. It was the same with Webvan, the grocery delivery service that saw its price tumble from $30 a share at IPO in November 1999 to just 6 cents a share when it ceased trading, 20 months later.

This is why focusing on fundamentals and the business model of a company can help investors avoid repeating the mistakes of the dotcom crash, when many were dazzled by the hype surrounding certain firms rather than focusing on their actual value, says Mark Leach, portfolio manager at wealth manager James Hambro & Partners. “Always focus on value, cash and profits. It’s a lesson that investors repeatedly fail to heed – that’s why these bubbles happen.”

Source: Two decades on from tech bubble trouble: is it different this time?, Money Observer

Another dot con of the late 1990s that disappeared is Infospace. The CEO of that firm went on TV to proclaim that his firm will be the first trillion dollar market cap in the world. After that fantastic prediction he went the way of the dodo bird never to be seen or heard again.

Nobody knows if tech stocks are in a bubble or not. One thing is clear. The tech stock industry always goes thru booms and busts. Currently we are in the boom side of the two categories.

Disclosure: No Positions