Donald Trump’s ascension to the seat of the President seems to have created a win-win situation for the aerospace and defense industry. The outlook for stocks in this space has improved manifold in recent months, notably with enhanced spending promises that Trump made in his latest “America First” budget.

In fact, defense stocks have been on an upward growth trajectory post-Trump’s election win last November. This raised investors’ hopes that Trump will indeed keep his word of “big” spending toward the nation’s defense.  

Impressively, stocks in the Zacks Aerospace sector (a stand-alone sector) are up 4.3% since Jan 20 (Inauguration day of President Trump), outperforming the S&P 500 index’s 3.9% gain. With the majority of macroeconomic factors favoring this industry, the outperformance can be expected in the days ahead as well.

U.S. Defense Scenario

Apart from enjoying the lead in terms of economic prosperity, the U.S. has literally turned itself into a hub of aerospace and defense equipment and allied products over last few years. Other countries, in like manner, are also spending on state-of-the art artillery, to stay privileged.

The need for this rapid evolution of advanced military weapons surfaced with the meteoric rise of the Islamic State of Iraq and Syria (ISIS), an organization that President Obama had termed “the network of death.”

Moreover, other factors like rising demand for more fuel-efficient aircraft, the growing international market for defense equipment with more developing nations increasing their share of defense spending and increasing application of unmanned aircraft in warfare today are driving sales in this sector.

Also, other macroeconomic statistics like improving employment in the private sector, a more-or-less stabilized oil price for past few months, and increasing core consumer price inflation boosted consumer confidence and is being reflected in increased consumer spending. In fact, in Jan 2017, the U.S. personal consumption expenditures (PCE) price index increased 0.4% – the largest gain since Feb 2013 – after rising 0.2% in December.

No doubt, this in turn will bolster the entire economy to grow at an accelerated pace. In fact, having high hopes on Trump’s supply-side economic reforms, market economists estimate the nation to witness 2.3% growth in 2017 against 1.9% growth last year.

Although, rising interest rates continue to be a spoil sport for an uninterrupted growth trajectory for this industry, its non-cyclical feature helps it to overcome all the oddities and thus has been stable for years. Therefore, the time is ripe for considering the aerospace and defense industry as one of the top performing ones.

Budget Updates

On Mar 16, 2017, President Trump unveiled the Pentagon's fiscal 2018 (FY 2018) budget proposal, with the intent of rebuilding the U.S. military force without increasing the Federal deficit. The proposed budget of $639 billion for the Pentagon includes a base budget of $574 billion. This reflects a $52 billion increase over the FY 2017 current budget level of $587 billion. Moreover, FY 2018’s base budget reflects a 10% increase from the current base budget level of this fiscal.

The budget also includes $65 billion in funding for the Pentagon’s overseas contingency operations (OCO) fund, which is also higher than the FY 2017 level by $2 billion. The combined request represents a total increase of $54 billion over the current FY 2017 level.

It is also important to mention that the FY 2017 defense budget of $587 billion has yet to be passed by the House or Senate. Trump recently offered another proposal to increase the current fiscal’s defense budget by $30 billion: $24.9 billion in base budget and $5.1 billion in OCO. This request also has a provision to include an additional $3 billion fund for the Department of Homeland Security (DHS) for urgent border protection activities. If this proposal gets approved, then there might be a change in FY 2018’s defense budget as well.

The FY 2018 budget proposal mainly addressed three key agendas: focus on keeping Americans safe, keeping terrorists out of the country and putting violent offenders behind bars.

Zacks Industry Rank – Mixed Bag

The Zacks Industry Rank relies on the same estimate revisions methodology that drives the Zacks Rank for stocks. The way to look at the complete list of 256+ industries is that the outlook for the top one-third of the list (Zacks Industry Rank of #88 and lower) is positive, the middle 1/3rd or industries with Zacks Industry Rank between #89 and #176 is neutral while the outlook for the bottom one-third (Zacks Industry Rank #177 and higher) is negative.

Aerospace is one of the 16 broad Zacks sectors within the Zacks Industry classification. Aerospace is further sub-divided into three industries at the expanded level: aerospace/defense, aerospace/defense equipment and electric-military.

Aerospace/defense is positive with a Zacks Industry Rank #77, placing it at top 30%. The Zacks Industry Rank for electronics-military is #4 out of 257 industries, which puts it at top 2%. However, aerospace/defense equipment with a Zacks Industry Rank #197 comes in at the negative territory of all Zacks industries, placing it at bottom 23%.

Earnings Review and Outlook

Every fiscal year, no matter how constrained the funding picture, the Pentagon almost always gets its way. Despite headwinds, the Aerospace sector held up well in the fourth quarter. The earnings beat ratio for the stocks in this space (percentage of companies coming up with positive surprises) was an impressive 80%, while the revenue beat ratio was 50%.

Going forward, the earnings picture for the first quarter of 2017 reveals a mixed bag. The sector’s earnings are expected to improve 0.2% in the first quarter, while revenues are expected to see a 1.3% decline (as of Mar 31, 2017). Margins for this sector are expected to nudge up 0.7% in the quarter. Notably, this sector is one out of the nine of the 16 Zacks sectors that are expected to exhibit positive earnings growth this quarter.

Defense Stocks Worth Adding

Investors might keep a watch on the following defense biggies that have the financial strength to withstand a gradual increase in the interest rate without compromising on dividend payments.

Huntington Ingalls Industries, Inc. (HII - Free Report) has a long-term earnings growth projection of 15%. This security stock registered positive earnings surprises in three out of the last four quarters, with an average beat of 19.85%. Its 2016 earnings estimates moved up 8.3% in the last 60 days. Huntington currently sports a Zacks Rank #1 (Strong Buy).

Leidos Holdings, Inc. (LDOS - Free Report) has a long-term earnings growth projection of 8.5%. This stock registered positive earnings surprises in two out of the last four quarters, with an average beat of 5.80%. Its 2016 earnings estimates moved up 2.5% in the last 60 days. Leidos currently sports a Zacks Rank #2 (Buy).

Lockheed Martin Corp. (LMT - Free Report) has a long-term earnings growth projection of 5.8%. This stock registered positive earnings surprises in all the last four quarters, with an average beat of 12.41%. Its 2016 earnings estimates moved up 0.2% in the last 60 days. Lockheed currently sports a Zacks Rank #2.

Summing Up

Increasing terrorist attacks across the globe have spurred nations to make heavy investments in their aerospace and defense industry. Some say it’s a “game for power,” while others say it’s just a “protective measure.”

In a big-picture sense, the aerospace and defense industry is a direct beneficiary of a volatile and uncertain geopolitical global backdrop, characterized by terrorist threats, civil wars and border disputes. The U.S., home to the world’s major weapons manufacturers, is potentially a big beneficiary of this environment. Its defense measures are therefore expected to grow manifold in the days ahead.