Market Overview

How Will Chuck Hagel Affect Defense Stocks?

Former Senator Chuck Hagel was picked by President Obama as his nominee for Secretary of Defense on Monday. Hagel's nomination could heighten concerns some have in regards to defense spending.

Republicans have been openly dubious about Hagel's candidacy for a wide variety of reasons. Among these reasons is a belief that he lacks a firm commitment to a large enough defense budget.

Hagel, a decorated Vietnam veteran, has illustrated a tendency to exhibit caution towards military involvement, even going so far as to vote against the troop surge in Iraq during the administration of George W. Bush, despite broad support for the move within his own party.

Hagel is on record as having labeled the defense budget as “bloated” -- which does little to allay Republican fears of defense budget cuts. His predilections for spending reductions and the likely end to our nation's current level of involvement in Afghanistan almost guarantee a decline in defense spending, even if the sequestration issue is resolved without significant cuts.

Reduced government spending will lead to reduced revenue for defense contractors, that much is clear. Investors should be wary regarding these types of stocks, but should also be careful not to treat every stock in this industry uniformly.

This may be easier said than done, however, as the top nine global aerospace and defense companies all have defense spending as their major source of revenue, with their largest customer, by far, being the United States.

Additionally, these companies potentially face not just a domestic decrease in demand, but a global one as well, as the international economic malaise remains very much ongoing.

Given the difficult economic times ahead, it is logical to expect that M&A activity would not only be supported, but actively encouraged by the United States government in an effort to keep the defense industry's impending struggles from impacting the overall economy.

Some of the major players in the industry have already completed such deals recently, including Lockheed Martin (NYSE: LMT) purchasing Chandler/May in December, Boeing Corporation (NYSE: BA) buying Miro Technologies in October, and Raytheon (NYSE: RTN) finishing the acquisition of the Government Solutions group of SafeNet in December.

Lockheed's stock has seen a rise in share price over the course of the first trading week of the year, up from $90.42 on December 31 to its current level near $94.

Meanwhile, Boeing and Raytheon have also both seen share price spikes, with Boeing increasing from $70.44 per share at the end of October to near $76 and Raytheon from $56.42 per share at year's end to near $58 per share.

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