The entertainingly cynical story (which I have cited before) that the stock in the British engineering company Vickers, a leading defense contractor, fell after the Munich agreement with Hitler was settled, prompting a headline in the Financial Times that the Vickers share price had been hit by “peace fears” may or may not be true (probably not), but it is a useful reminder that the stock market can be a cold, cold place.
Dave Sheaff Gilreath, writing at CNBC (December 1):
In times of war, investors’ thoughts naturally may turn to defense stocks.
The Daily Telegraph (January 2):
British defence stocks have risen to a record high as tensions in the Middle East and the war in Ukraine continue to stoke global demand for military hardware. The UK benchmark for defence and aerospace companies surged 1.4pc to 8,710.43 points on Tuesday, the highest figure on record.
Among the winners were Babcock International, BAE Systems and Rolls-Royce, which jumped 3.5pc, 1.8pc and 1.9pc respectively in early Tuesday trading. The FTSE All-Share Index for defence and aerospace stocks has climbed by more than 200pc since October 2020, when the Covid pandemic was still raging.
And it’s the same story elsewhere (the Financial Times, December 27):
The order books of the world’s biggest defence companies are near record highs after growing by more than 10 per cent in just two years because of rising geopolitical tension, including the conflict in Ukraine.
An analysis by the Financial Times of 15 defence groups, including the largest US contractors, Britain’s BAE Systems and South Korea’s Hanwha Aerospace, found that at the end of 2022 — the latest for which full-year data is available — their combined order backlogs were $777.6bn, up from $701.2bn two years earlier.
The trend’s momentum continued into 2023. In the first six months of this year — the latest comprehensive quarterly data available — combined backlogs at these companies stood at $764bn, swelling their future pipeline of work as governments kept placing orders.
The sustained spending has spurred investors’ interest in the sector. MSCI’s global benchmark for the industry’s stocks is up 25 per cent over the past 12 months. Europe’s Stoxx aerospace and defence stocks index has risen by more than 50 per cent over the same period.
The gains reflect conviction among investors that higher defence spending by governments is here to stay. Total global military expenditure increased by 3.7 per cent in real terms in 2022 to a new high of $2,240bn, according to the Stockholm International Peace Research Institute. Military expenditure in Europe had its steepest year-on-year increase in at least 30 years as governments in the region announced new orders for ammunition and tanks to replenish national stockpiles depleted by donations sent to Ukraine.
Typically investors look ahead, so the fact that the increased spending on weapons is yet to be reflected in company bottom lines is neither here nor there.
The Financial Times:
Not all of the higher spending is related to Ukraine. BAE Systems’ order backlog, for example, has risen from $61.8bn to $70.8bn in 2022 thanks to new orders for existing programmes, including submarines, frigates and fighter aircraft. Its order backlog hit a record $84.2bn in the first six months of 2023.
Some of the causes of higher backlogs predate Russia’s full-scale invasion of Ukraine, according to Nick Cunningham, analyst at Agency Partners. “The reality is lead times for policymaking, budgets and placing orders are so long that the invasion of almost two years ago is only just appearing in orders and barely in revenues, except for a few shorter-cycle specialists such as Rheinmetall,” he said.
Despite receiving new orders, many European and US defence companies have struggled to significantly increase production capacity amid persistent supply chain disruptions and labour shortages. Analysis by Sipri of the 100 largest companies found that revenues from sales of arms and military services totalled $597bn in 2022, 3.5 per cent less than 2021 in real terms, even as demand rose sharply.
Cunningham said the order pipeline “looks really strong, so we expect more to come in”. He expects the “book to bill ratio” — the ratio of orders to deliveries — to stay above one, meaning backlogs should “increase for some time to come”.
Of course, there are many factors that investors take into account when deciding which shares to buy, from valuation to the state of the broader market, to their views on what other investors are going to do. That last factor was something that intrigued Keynes (who, despite some grim periods, was generally a very successful investor).
Richard Thaler in the FT (July 10, 2015):
Keynes thought that professional money managers were playing an intricate guessing game. He likened it to a common newspaper game “in which the competitors have to pick out the six prettiest faces from 100 photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole: so that each competitor has to pick, not those faces that he himself finds prettiest, but those that he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. . . . We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth, and higher degrees.”
He had a point, I think.
We don’t give investment advice at Capital Matters, but watching the performance of defense-related stocks is one way of gauging the degree of nervousness about an international situation that currently gives no great grounds for comfort.