Nobody spends money like Uncle Sam. Nobody.
According to the latest State Department records, in 1999, the U.S. military spent $281 billion. The next-closest was China, which spent $88.9 billion. After China, there's another huge drop to Japan, which spent $43.2 billion. Our closest ally, Great Britain, came in fifth with $36.5 billion. What about one-time superpower Russia? It spent $35 billion. Rounding out the top 15 was Israel, which spent $8.7 billion.
In a nutshell, when it comes to military hardware, the U.S. military is sporting platinum compared to the rest.
But are the enormous U.S. defense budgets a thing of the past? If you're considering an investment in defense contractors like Northrop Grumman (NYSE:NOC), Boeing (NYSE:BA), General Dynamics (NYSE:GD), or even small fries like DHB Industries (AMEX:DHB), having a perspective on U.S. military spending might help.
Is Uncle Sam cutting back?
A word of caution that you may hear in this wartime environment is that big defense programs may be scaled back or cut altogether, to pay the bills for immediate needs. There is certainly some truth to this.
In December 2004, the Pentagon announced that it may reduce the number of F-22 Raptor deployments. Lockheed Martin's stock (NYSE:LMT) didn't weather the news well, as it lost 18% of its value in a month. Since then, the market has had plenty of time to digest the news, coming to the realization that government plans don't always become reality.
To appease constituents, congressional leaders will be awfully slow to act on these types of cuts. And at least Lockheed Martin shareholders are betting as such, having forgotten the so-called bad news altogether -- and running up the stock a quick 27%.
Missile defense, C-130J transport crafts, and naval ships are also being tossed up for budget-cutting fodder. But, hey, this is the "never seen a dime that couldn't be spent" Congress that we are talking about. One defense analyst commented on Congress' habit of restoring projects the Pentagon had cut, indicating that this practice is nothing new. I guess it makes too much sense to take proposed budget cuts at their face value.
But let's super-stretch our imagination and assume the government scales back a few programs. Is it the end of the world for defense-concentrated investors? Not hardly. For every revised or canceled project, there is plenty of money spent on immediate needs. Just one of the numerous examples is a recent announcement of $56 million being awarded to General Dynamics for repairs to Abrams tanks returning from Iraq. From rehabbing to redesigning, there is a lot of work to go around for defense contractors.
$400 billion is a lot -- or is it?
Even if the U.S. military decides it can live with a few less Raptors, it cannot go without adequately supplying and protecting fighting men and women. Advanced Interceptor vests used to protect troops on the ground in Afghanistan and Iraq are one such immediate need. DHB Industries, maker of the Interceptor, received a windfall of contracts in 2004 as its stock skyrocketed from $7 in January 2004 to the low $20s in December.
While DHB Industries' rapid rise in 2004 was impressive, it's the 30-year sustainable rise of stock values from giants like General Dynamics that make investment legends. But as General Dynamics and the defense industry shoot toward record highs, investors new to the scene may be wondering if the good times have passed.
Yes, and no.
Since the war on global terror got underway, there's been a lot of talk about "record" defense spending. The $400 billion-plus figure requested in the 2006 budget seems like an awful lot, but in reality it's not. Current U.S. military spending at around 4% of gross domestic product (GDP) is equal to the percentage of GDP in the 1990s, well shy of the 6% in the 1970s and 1980s, not even close to the 9% of the 1960s, and a far cry from the over 10% of GDP in the 1950s.
Even $400 billion defense budgets are nothing new. When adjusted to 2002 dollars, the proposed 2005 defense budget is shy of the defense budgets from wartime years of 1952 to 1954, 1967 to 1970, and the height of Cold War spending from 1985 to 1990.
What the future holds
The fact that $400 billion defense budgets are nothing new is the good news for defense investors. The bad news is that seasons come and seasons go, and while it may be raining Uncle Sam dollars today, history suggests that a drought may come tomorrow.
Each of the peak wartime periods (typically lasting three to four years) mentioned were immediately followed by significant reductions in defense spending. Oftentimes droughts -- decreases in spending as a percentage of the GDP -- would last for at least a decade.
So while the defense industry may be in a sweet spot right now, if history is any indicator, it won't last. What does this mean for Foolish investors interested in the defense industry? Be a price-conscience investor, and wait for deep discount opportunities.
Stocks like General Dynamics and Boeing may continue to run wild for the immediate future. Given this possibility, investors may consider dipping a toe into one of their favorite defense stocks just to hop along for the ride. Be conservative in determining an entry price and extra cautious before allocating a significant portion of your cash to these stocks.
The U.S. government can seemingly throw caution to the wind when spending cash -- Foolish investors cannot. Be patient and wait for bargain shopping days, as history suggests that Uncle Sam's spending spree will most certainly come to an end.
To read the latest Foolish perspectives on defense industry stocks, check out these highlights:
- Northrop, This Way and That
- The Best Offense
- Marriage of Convenience
- Lockheed's Embattled Fighter?
- Real-Life Battlebots
Fool contributor Jeremy MacNealy does not own shares in any of the companies mentioned. The Motley Fool is investors writing for investors.
