The theme of the conference will share insight into developments in biodefense, biometrics including fingerprint, voice and facial recognition, cyber security and other security and defense issues. The agenda will include a financial panel, and industry panel and presenting companies showcasing their technologies. The current list of speakers represents some of the top thought leaders in biometrics and cybersecurity including cybersecurity expert and counterterrorism analyst Roger Cressey.
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Investorideas.com: Let's start with a quick recap of 2013 and the start of the first quarter.
SMS: A good place to start. Although many though the year would be all gloom and doom for the sector with the Pentagon's budget on a downward slope from the peak in war spending and the expected impact from sequestration, I held a more moderate view. Although there would be stress in the system, I believed that the rise in sales to international defense customers combined with the upcycle in commercial aerospace spending would offset the U.S. government budget declines and things would not be as bad as some forecasted. But even I couldn't foresee how good a year it would become. By the end of 2013, the SPADE Defense Index has gained 48.18%, nearly 20% more than the gain in the S&P500.
Investorideas.com: And the start of 2014?
SMS: The sector is still at or near its historic high. Year to date, the market is down 0.4% but the aerospace and defense sector is up 3.4%.
Investorideas.com: Any patterns you've seen in the numbers?
SMS: We noticed in 2013 that investors interested in the sector appeared to choose individual companies over fund-related —whether Boeing, which was up 81% in 2013 or Lockheed Martin, which gained 61% while offering a 4% dividend. Toward the end of 2013 and continuing through the beginning of the year, we've noticed an inflow into funds such as PPA. This makes some sense after the sector's significant gains in 2013. The ETF gives exposure to the sector and diversification from positions in any one company. Although most firms reported good numbers in their Q1 reporting, comments from Boeing executives regarding their forecast for 2014 spooked the markets and caused the stock to tumble by more than 11% in a ten day period. Fund products offer diversification which gives some investors comfort so a shift was probably inevitable.
Investorideas.com: How do you see the year shaping up going forward?
SMS: Congress and the White House reaching agreement on an FY-14 budget is a great positive as it starts to clarify what the Department of Defense can and will do with the funds allocated to them. A proposed $535 billion core budget would be $36 billion over the sequester-mandated cap with the administration offsetting this increase by reducing other areas in the federal budget. According to Defense News, as part of the budget deal agreement put forth by Sen. Patty Murray and Rep Paul Ryan, the expected budget to be submitted to Congress on March 4 th for 2015 is roughly $496 billion and it includes about $30 billion restored to the Pentagon in 2014 and 2015. We can start to think of these years as the end of the transition period and a stabilization of the current budget puts us possibly near to the bottom of the budget cycle which should stay flat to improving over the next several years and the budget seeing a boost starting in FY16.
Meanwhile, international sales continue to provide a boost to the domestic market and have a meaningful impact on the bottom line of the large firms. Commercial aerospace, which is still in the early innings of a multi-year cycle, is highlighted by Boeing's backlog for new planes stretching to the end of the decade. Newly announced plans to bridge the 777 with a newer plane in 2020 could stretch the commercial aerospace upcycle to the early part of the next decade fueled by global travel growth.
Investorideas.com: And what concerns would keep investors up at night?
SMS: First, with this Congress and White House, there is always political risk and the plans for defense spending mentioned above could easily change. But at least for the moment, the acrimony appears to be calming down a bit. Second, after such a huge run in the stock market during 2013, some companies are near the top of their valuations. So while economic growth is still expected in 2014, which will help justify their valuations, this year is expected to be more of a stock pickers market. Inflows into ETFs are a signal that investors are confident in a sector and want to stay exposed but might be unsure which firms are the clear winners or which firms are at their peak valuations. While shares in the funds being held by investors are up 50% in just the past two to three months, it is still down 75% from its peak. Although we see the sector performing at least in line with the broader market over the rest of the year, if there is an economic hiccup causing investors to pocket gains and pull funds out of the market, stocks overall would see a decline, not just the aerospace and defense sector.
Investorideas.com: Looking at the future of defense technology, which ones and who do you see as benefitting?
SMS: Glad you asked. I will be spending time at the InvestorIdeas.com Security and Defense Conference on March 11th  in New York City and the event is designed to talk about just this.
While wars are obviously to be avoided if at all possible, the post-war environment has historically been a prime period for innovation. Live conflict gives military commanders and planners a chance to evaluate what worked and what didn't work. And from these discussions needs are identified, a plan of action is put in place, and resources are allocated to develop the systems and technologies to eliminate the perceived shortcomings. While new technologies may spring up that provide the military with a previously unforeseen strategic edge, much of the R&D that occurs fits into one of two categories: (1) fixing problems and meeting needs and (2) developing counter technologies.
Additional opportunities can also come from the wave of military personnel entering or returning to the non-military workforce and take the technologies and the lessons learned in warfare and applying them to more, let's say, mundane applications. Post-war medical services and triage capabilities rise as an influx of trained personnel return to society. The application of GPS and positioning technologies for commercial activities expanded after the Gulf War in the 1990s. Although the military bought many of its commercial handheld devices from suppliers such as Radio Shack (true, by the way), GPS becoming a commonplace tool took off following the war as hundreds of thousands of people gained familiarity and exposure to the technology.
Investorideas.com: So what types of technology can we expect to see a boost in the near-term?
SMS: I think they’d fall into three categories.
First, protect the soldier when they are exposed to dangerous situations; and reduce the weight they have to carry through multi-purpose electronics, better reusable power sources, and new water technologies.
Second, the digital warfighter, namely improving the interoperability of different systems they have to use and not overwhelming the soldier with information; and
Third, cyber which is an ongoing battle that is currently being fought on multiple fronts. Investors should obviously keep their eyes open for opportunities in each of these areas.
Investors should obviously keep their eyes open for opportunities in each of these areas.
Investorideas.com: You also mentioned counter technologies.
SMS: Yes, thanks for bringing that back up. If we look back at the history of warfare, it's always been a concept of gaining an edge over ones enemies or adversaries. Whether better bows and arrow, catapults or more modern examples. The implementation of the tank in World War I was designed to disrupt trench warfare. Advances in guns and projectiles led to armor shielded vehicles which in turn led to anti-tank weapons. Planes led to anti-aircraft and radar technologies which in turn spawned the need for missiles which were faster and harder to shoot down. Satellite sensors and missile warning systems were then developed to prevent enemies from shooting down spy planes and identify the launch of missiles and rockets to provide more time to mount a proper defense. GPS enabled more precision targeting of expensive ordnance so technologies to jam and disrupt the signals were developed. IEDs were used to disrupt U.S. forces in Iraq so technologies were developed to counter whether V-shaped undercarriages of vehicles to divert the force from the explosion to improved armor and plating for vehicles. It's a cycle. Roughly every twenty years for more than a century, new technologies and systems are developed that change the way warfare is conducted. And these revolutions led to the development of counter technologies and counters to the counter. It essentially exists for every system and technology in play.
Investorideas.com: Thank you. Something for our readers to think about.
Scott Sacknoff manages the SPADE Defense Index which serves as the underlying index for InvescoPowershares Aerospace & Defense ETF (NYSE ticker: PPA).
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See the growing list of companies: http://www.investorideas.com/Conference/Companies.asp
Investorideas.com Security and Defense Conference:
Game Changing Technologies: The Face and Future of Security
Tuesday, March 11, 2014
The New York Hilton Midtown and Online at a unique content and syndication platform
Investors, media and industry service providers: Register here free: http://www.investorideas.com/Conference/Conference-Registration.asp
Presenting Companies: Visit the conference page to learn more and sign up:
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