Santa Claus, the Easter Bunny, and Defense Spending Cuts

Do you believe in Santa Claus? How about the Easter Bunny, magical unicorns, and leprechauns with pots o' gold? If so, then you're probably also … well, at least open to the possibility that the pundits are right, and President Obama has his heart set on gutting the U.S. defense budget.

Problem is, just like the mythical creatures listed above, the threat to defense spending is a total myth.

The tales we tell our children
Listen to the pundits, and they'll tell you that the president has it in for defense contractors. He drove a stake through the heart of Boeing's (NYSE: BA  ) Future Combat Systems program, pushed Raytheon's (NYSE: RTN  ) Kinetic Energy Interceptor off the road, and plucked the feathers from Lockheed Martin's (NYSE: LMT  ) F-22 Raptor. In short, he's left the U.S. mainland naked and defenseless before our foes.

Well, balderdash.

Numbers don't lie
Folks, it's just not true -- and I've got the numbers to prove it. On Monday, the administration produced for Congress its fiscal 2011 budget request, and you'll be shocked (shocked, I tell you) to learn that far from slashing spending on defense, the president has raised the defense budget.

Depending on which supplemental items (such as funding for the 2010 Afghan troop surge, or benefits for vets returning home) you choose to class as "defense spending," the total 2011 U.S. defense budget amounts to as much as $708 billion. But even the base budget looks pretty darn beefy to me.

In fact, the base budget of $549 billion works out to a 3.4% increase in spending over the $531 billion allocated in 2010. And it's got a little something in it for everyone: New armored vehicles for the Army, F-35 fighter jets for the Air Force, a brand-spanking-new ballistic missile sub for the Navy, and enough hi-tech drones, robots, e-warfare gadgets, and cybersecurity toys to fill Santa's bad to bursting (if Santa existed, that is).

Guns or butter? You're a growing boy -- have some of both
Also false is the theory that Obama is emphasizing pay and benefits for more troops over hardware purchases. While it's true the president's funds request doesn't stint on the benefits for the boys in blue (and khaki and olive), that doesn't mean the Pentagon's going to be lacking for hardware, either. To the contrary, weapons procurement is rising twice as fast as overall defense spending, up 7.6% year over year.

A kernel of truth
So where (oh, where) do folks get the impression that the president is cutting defense spending? From the media, obviously, which love a good story of defense plants being shuttered in the middle of a recession. From the industry's lobbyists, too. And in fact, there's even a kernel of truth to this side of the story -- the budget does in fact aim to cut spending on many programs. Once again, we see the Obama administration trying to throttle back on funds for Boeing's C-17 transport plane, and to stall support for an alternate General Electric (NYSE: GE  ) engine to power Lockheed's F-35. Among other cuts, the Pentagon hopes to delay the purchase of two new command and control ships for the Navy, and they will slash by ground combat vehicle purchases manufactured by the likes of General Dynamics (NYSE: GD  ) .

The more things change, the more they … don't
But here's the key point to remember: Defense spending isn't being cut per se. It's being increased -- and allocated to different priorities. Our mission as investors in defense companies is to figure out where the new priorities lie, and invest in them before the stocks rocket.

Fortunately, the Obama administration has been crystal clear on where it intends the military to march going forward. Defense Secretary Gates laid out the plan of attack last year, and for the most part, it remains unchanged.

"Asymmetric warfare"
These are the Pentagon's twin watchwords today. As contrasted with years past, the U.S. today faces opponents considerably more skilled in the Zen Art of AK-47 Maintenance than at conducting large-scale tank warfare on the plains of Western Europe. Accordingly, the weapons favored in the Pentagon budget are primarily of the "aim small, miss small" variety: unmanned aerial vehicles like General Atomics' Predator drone, for hunting insurgents in rough terrain, and United Technologies' (NYSE: UTX  ) famed Blackhawk helicopter, for transporting special ops in nations lacking a well-developed system of interstate highways.

Looking forward, too, the Pentagon is trying to envision the opponents it might face and the unconventional battlefields in which we might face them. The budget request makes particular mention, for example, of the need to fund electronic warfare initiatives, and to make improvements in military cybersecurity. (So it seems Google (Nasdaq: GOOG  ) had a point.)

Moral of the story
Now every fairy tale needs a moral, and even in non-fiction, it never hurts to have a point -- so here's mine: Investing in the defense industry isn't as simple anymore as it was under President Bush. You can't just say: "We need tanks. General Dynamics makes the best tanks. Buy General Dynamics." Instead, you need to be as imaginative as the Pentagon, and invest in the threats that it imagines most relevant today. The opportunities are still out there, waiting to be discovered.

If you haven't found 'em yet, ask the Easter Bunny. I hear he knows all the good hiding places.

Or heck, take a free trial of Motley Fool Rule Breakers, our asymmetrical investing newsletter, where we've uncovered opportunities in everything from UAVs to missile defense, from bomb-proof trucks to bulletproof soldiers. 30-day free trials are available on demand.

Fool contributor Rich Smith is does not currently own any stocks named above, but General Dynamics is a Motley Fool Inside Value recommendation and Google is a Motley Fool Rule Breakers selection. The Motley Fool has a disclosure policy.


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  • Report this Comment On February 02, 2010, at 5:13 PM, Retired31B5M wrote:

    The problem with the current procurement stragety is that it is making the mistake of assuming that the next war is going to be like the current war.

    If - for example - the next war is with China over Taiwan, then all of those light-infantry devices will be on the sidelines while ships and advanced aircraft will be doing most of the fighting.

    With the decades-long cycle times for military technology we need to be focusing on 2020 instead of 2010.

  • Report this Comment On February 02, 2010, at 10:20 PM, kamuirei wrote:

    The following is a line of thought post. (Aka I ramble) Skip to the caps lock'd text for my point.

    Isn't this really old news? I swear those numbers came out months before the official budget... they "cut the budget" but went up 3.4%. The Daily Show had a ball blasting Fox for that fiasco.

    Didn't Obama just say defense spending is exempt from his upcomming cuts? Last week? He's cutting discretionary spending. Not Defense, not Medicare, not Homeland Security.

    Something is extremely off on the timing of this article. Any trades based on this information should have happened long ago, not now.

    Something more relevant would be the scrapping of the Moon mission's impact on defense companies.... oh wait, read that article last week too. Additionally who is getting money from NASA to take our astronauts into space.

    --Confirmed my memory--

    Go Google: "daily show defense budget"

    http://vodpod.com/watch/1508309-stewart-lampoons-defense-spe...

    THE RECCOMENDATION WAS MADE APRIL 6th 2010! - 10 months ago - not last week. You even stole Stewart's idea for a holiday reference.

  • Report this Comment On February 02, 2010, at 10:20 PM, kamuirei wrote:

    http://vodpod.com/watch/1508309-stewart-lampoons-defense-spe...

    This was news 10 months ago, don't trade on this now.

  • Report this Comment On February 03, 2010, at 12:48 AM, TMFDitty wrote:

    Actually, 10 months ago we were talking about the fiscal 2010 budget:

    http://www.fool.com/investing/general/2009/04/09/lockheed-de...

    Now we are talking about the fiscal 2011 budget. Different stories. Same theme: The numbers are going up, rather than down.

    TMFDitty

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