When Russia annexed Crimea from Ukraine, already strained relations between the United States and Russia became even more precarious. In fact, tensions escalated so much that a Russian fighter made low-level passes near a U.S. destroyer stationed in the Black Sea. More pointedly, this was undoubtedly Russia's way of showing resentment over the destroyer being stationed in the Black Sea in the first place.
Given the above provocations, it's easy to think that this conflict in Ukraine is good for defense companies. But is that the case? More importantly, what could lead to a defense-spending spree?
Are defense companies set to prosper?
It's no secret that defense-spending cuts, aka sequestration, have negatively affected defense companies. What's more, this trend doesn't show any signs of abating. This is because the Budget Control Act of 2011, or BCA, mandated across-the-board spending cuts, which lowering planned defense spending by over $1 trillion from FY 2012 to FY 2021. Clearly, this isn't the best news for defense contractors, but could the conflict in the Ukraine change that?
Honestly, probably not; and the reason is unless something is established as a disaster or emergency, spending cannot exceed the BCA's established spending caps. For example, Hurricane Sandy was declared a disaster, and therefore made local governments eligible to receive disaster relief -- however, that was still subject to a disaster spending cap.
Consequently, while the conflict in Ukraine has escalated tensions between the United States and Russia, it's not at the point where defense contractors will benefit. However, if the conflict in Ukraine escalates to the point of all-out war between the United States and Russia, that could be declared an emergency and qualify for emergency supplemental appropriations, aka emergency funding.
Emergency funding and sequestration
Emergency funding is exactly what it sounds like -- funding that Congress can quickly approve in cases of emergencies. Further, it's exempt from ceilings that apply to discretionary spending. Case in point, at the start of the wars in Iraq and Afghanistan, President Bush funded the wars largely through supplementary spending bills -- between 2000 and 2010, emergency funding exceeded $980 billion.
Even under the BCA, emergency spending is uncapped. However, there are certain definitions that must be met in order for something to qualify for emergency spending. According to the BCA, some of these definitions are:
(20) The term "emergency" means a situation that—
(A) requires new budget authority and outlays (or new budget authority and the outlays flowing there from) for the prevention or mitigation of, or response to, loss of life or property, or a threat to national security; and
(B) is unanticipated.
(21) The term "unanticipated" means that the underlying situation is—
(A) sudden, which means quickly coming into being or not building up over time;
(B) urgent, which means a pressing and compelling need requiring immediate action; (C) unforeseen, which means not predicted or anticipated as an emerging need; and (D) temporary, which means not of a permanent duration.
A war with Russia would absolutely meet these requirements.
What this means for defense contractors
Right now the conflict in Ukraine is not at a point where defense contractors will see a spending spree. Yes, it's an unnerving conflict that's escalated tensions, but so far the United States has responded mainly by threats of increased economic sanctions against Russia, and pledges of American aid to Ukraine. Unfortunately, Russia has largely ignored the threats. Will this lead to war? Truthfully, there's no way of knowing what will happen. But, there are strong incentives for the U.S and Russia to avoid such an encounter. Consequently, while the conflict in Ukraine has increased tensions between the United States and Russia, currently, a defense-spending spree is unlikely.
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Katie Spence owns shares of Northrop Grumman. The Motley Fool owns shares of Lockheed Martin, Northrop Grumman, and Raytheon Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.