Here's How Defense Investors Should React to the Blue Wave

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Defense investors spent much of the second half of 2020 worried about a “Blue Wave” election in which the Democrats ended up in control of the White House and both houses of Congress. Defense titans including Lockheed Martin (NYSE:LMT) and Northrop Grumman (NYSE:NOC) each underperformed the S&P 500 by more than 25 percentage points in 2020 as the concern grew.

That fear became a reality on Jan. 6, when two Georgia runoff elections were certified and we knew for sure the Senate was officially changing hands. Appearing on Motley Fool Live on Jan. 6, Motley Fool contributor Lou Whiteman discussed the post-election outlook for the sector, and explained why he is still bullish on defense stocks. 

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Lou Whiteman: That means the Democrats will control the White House and both houses of Congress for at least the next two years. This is what defense investors were worried about and it’s certainly the worst case heading into the election season for defense stocks. We saw a lot of them trade down. They had a really bad second half of 2020 in anticipation of this. I don’t think it’s a reason to hit the panic button and I want to tell you why.

First, we knew going into this year that we had had a good run of Pentagon spending increases, and no matter who won the election, the momentum had to slow. Just to give you some numbers here because they are really mind-boggling, Department of Defense contract spending, the part of the defense budget that goes to contractors, it was $420 billion with a “b” in fiscal 2020, up from 404 for the year prior. So contract spending was up 10%, the overall budget increased by 3.6%. The contractor share of the budget grew by about 300 basis points in just one year to 62% of the total budget. That’s a lot of things. That’s stationary at the bases, that’s food for the troops. That’s not just warplanes. But still we’re talking huge spending.

This has to slow. But there are also real urgent needs inside the Pentagon right now. President-elect Biden has been very clear he supports the Pentagon’s modernization plans, which are already rolling forward and money has already been spent. You factor in the slim majority is especially in the Senate, it’s hard to imagine spending falling off the cliff. If anything, I think we’ve gone from flatline to maybe slightly down over the next five years. But we’re not going to see a dramatic decrease. If anything, single party control may help to get things done. We may have a smoother budget process because there isn’t the gum in the works so maybe even a two year budget which gives rare clarity to these companies that are usually going year by year. The major contractors had tens of billions of dollars in funded orders in their backlog that can get them through even the worst case for a few years. Don’t panic. Jason was just talking about trying to just ignore the noise and focus on good companies for the long term. There is nothing about this political season that should change the long-term view on defense stocks. Without getting into my biases, based on the way they just stayed flat over the last six months, with people worrying about the election, there are some real interesting companies to look at right now. So just stay calm and move on.