Doomsday Is Postponed
“The dogs may bark, but the caravan moves on.”
— Kahlil Gibran
Doomsayers often become so enamored of their pessimism, they refuse to acknowledge any evidence that contradicts their cherished predictions of catastrophe.
Case in point: the dire scenarios surrounding the “fiscal cliff” of tax increases and spending cuts slated to take effect January 1.
As of this writing on Dec. 31, seesawing negotiations on Capitol Hill had yielded no compromise. But let’s put aside the partisan slugfest in Washington and simply focus on the underlying economic and business fundamentals that should convey plenty of cheer for investors in the coming new year.
The world didn’t end on Dec. 21, as the Mayan calendar supposedly predicted; neither will it end on January 1, as the political wonks within the Washington Beltway warn.
To be sure, the consequences of going off the cliff are real and unpleasant: more than half a trillion dollars in tax increases on virtually every American, combined with $100 billion in “sequestration” cuts across the federal budget. That’s not an outcome that any investor should want. But it’s also no reason to panic and dump solid stocks.
January 1 is not the make-or-break date that the public has been led to believe. When a new Congress is sworn in on January 3, the divided body will get additional opportunities to reach accord and undo some of the damage. In the meantime, various stopgap measures are available to the federal government, to forestall some of the harshest consequences if the brinksmanship continues into 2013.
It ain’t over until the fat lady sings, and she’s still only warming up.
Notably, even if the nation falls off the cliff, the Obama administration has already instructed federal agencies to continue spending money as if the old, 2012 authorizations were still in effect, until a deal is reached. I’m betting that certain segments of the budget will ultimately escape the paring knife.
Let’s start with the massive defense sector. The Department of Defense (DoD) budget for 2012 is roughly $525 billion, up 89 percent since 2001. Regardless of any fiscal cliff deal, the US defense budget is on track to grow over the next five years.
Based on the consensus numbers now bandied about by the White House and key leaders in Congress and the Pentagon, defense spending starts on an upward path next year, reaching $567 billion in 2017, representing a 6.8 percent increase over 2013.
The US spends far more on defense than any other nation on earth. This enormous largesse for US-based contractors will continue far into the foreseeable future, despite the inevitable ebbs and flows.
That’s why all of the chatter about draconian defense cuts is unwarranted; they probably won’t happen. It’s revealing that some of the (albeit failed) proposals floated by House Speaker John Boehner in late December to avert the fiscal cliff have included a reprieve from sequestration for only one area of government spending—defense. Virtually everything else has been put on the chopping block in one way or another.
I expect the imminent creation of a “loophole” in Congress that spares the military from large cuts. When that happens, the now-depressed prices of defense stocks will spike.
The Pentagon firmly maintains its grips on the purse strings and it always gets a huge chunk of the budgetary pie, regardless of political vicissitudes. As you can see from the chart below, the defense budget hardly falls off a cliff between now and 2017.
Source: Center for Strategic and Budgetary Assessments
Defense contractor revenue and profits will not only survive the next few years but also thrive—making this a rare buying opportunity for investors to pick up inherently strong defense companies on the cheap.
Moreover, foreign exports of American-made weapons systems—especially emerging market demand for sophisticated fighter aircraft—will more than make up for any programmatic cutbacks. Rising nations in the Asia Pacific region are ordering a plethora of expensive combat jets from US aerospace manufacturers.
Honeywell International (NYSE: HON) faces particularly excellent prospects in 2013, because it supplies the ultra-complex avionics and electronic components that major military manufacturers need. Honeywell also benefits because it’s diversified in both the commercial and military sectors; the company’s foothold as a supplier for popular commercial airliners positions the stock for “take off” amid an improving aviation sector in 2013.
Among the largest defense stocks, the best opportunities lie with Boeing (NYSE: BA), Lockheed Martin (NYSE: LMT), and Raytheon (NYSE: RTN). All three are trading at attractive valuations compared to their peers and their growth prospects, but their share prices have been talked down by the budgetary wrangling on Capitol Hill.
Raytheon is particularly interesting because it is a technology leader in unmanned aerial vehicles (UAVs), a weapon much in demand and operationally vital in strife-torn places such as Afghanistan.
Annual spending on UAVs will almost double over the next decade, to $11.4 billion. That amounts to more than $89 billion in expenditures; Raytheon will get a huge chunk of that spending.
The Tech Titans Still Stand Tall
Cisco Systems (NASDAQ: CSCO), Intel (NASDAQ: INTC) and Qualcomm (NASDAQ: QCOM) may be on the conservative side as technology stocks, but they exemplify the strong underlying fundamentals that I look for in a stock. All sit on big cash hoards and control proprietary technology that’s increasingly coveted by consumers and businesses around the world.
These three companies are leaders in their respective niches—Cisco in networking technologies, Intel in semiconductor manufacturing and Qualcomm in chips for smartphones.
Lots of cash on hand provides these companies with a cushion for any market downturn; it also allows them to make the consistently strong research and development (R&D) spending that’s necessary for tech companies to maintain their competitive edge.
Meanwhile, corporate America has compiled a record amount of cash that it intends to tap for long-deferred IT investments, another boon in 2013 for this trio of technology stalwarts.
Admittedly, Intel’s stock has taken a beating over the last few months because of the worldwide downturn in PC demand, but it’s now a bargain and poised for a comeback in 2013 as consumer demand for PCs resurges. In addition, Intel is finally making belated forays into the exploding smartphone market with a new and advanced chip.
Another big tech stock I like should come as no surprise: Apple (NASDAQ: AAPL). This iconic and beloved brand name has zero debt and is now sporting a very attractive valuation.
The stock has come under pressure lately because of reports that its supply chain is adjusting to lower orders, but these concerns should prove ephemeral as demand picks up during a recovering global economy in 2013.
The emerging market appetite for Apple’s gadgets will remain strong for the next several years, as incomes rise and consumer discretionary spending mushrooms.
Apple has racked up an average annual earnings growth over the past 5 years of more than 62 percent—that’s stunning by any yardstick. Wall Street’s consensus is for average annual earnings growth for the next 5 years of nearly 20 percent. With a trailing price-to-earnings (P/E) ratio of less than 12, the stock is a bargain right now.
Don’t succumb to “groupthink” and get your knickers in a bunch over the fiscal cliff. Sure, budgetary and tax realities in 2013 will be less than optimal, but they shouldn’t alter your number one goal as an investor: to focus on intrinsically strong companies with solid long-term prospects. Have a happy, not a dyspeptic, new year.
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John Persinos is managing director of Investing Daily and Personal Finance.