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The Pentagon’s $250 Billion Windfall For Investors

By John Persinos on December 5, 2016

Despite the demagoguery you heard during the presidential campaign about America’s supposedly neglected military, the Pentagon isn’t exactly rattling a tin cup. The United States spends more on defense than the next seven countries combined.

Under Donald Trump, the country’s already massive military budget is about to get a whole lot bigger.

Small wonder that the SPDR S&P Aerospace & Defense ETF (NYSE: XAR), the aerospace/defense sector’s benchmark exchange-traded fund, has soared 14.3% over the last month and 23.3% year to date, compared to gains of 5.2% and 7.7%, respectively, for the S&P 500.

The coming defense spending boom is one of the surest secular trends you can find. Persistent terrorism threats, intensifying global conflicts, and an incoming commander-in-chief who’s extremely hawkish add up to multiyear growth for aerospace/defense stocks.

I’ve closely covered aerospace/defense for more than 25 years and I’ve never seen conditions better for investors to profit from a defense build-up. But don’t take my word for it.

Jim Fink, chief investment strategist of Options for Income and Velocity Trader, succinctly states the bullish case:

“Trump’s defense plan could add $250 billion more to U.S. military spending over the next four years.”

Igor Greenwald, chief investment strategist of MLP Profits and managing editor of The Energy Strategist, provides geopolitical context. Igor asserts that the Washington Beltway’s clueless pack journalists” are missing the huge implications of Trump’s confrontational foreign policy:

“I happen to believe the market is… underestimating the risk of a geopolitical shock like military action in the Persian Gulf.

That’s hardly surprising given the news flow right now. It’s all about the Trump policy agenda, with none of the inevitable delays and unintended consequences that are sure to crop up. Meanwhile, Trump’s stated intent to confront Iran and tear up the multinational nuclear accord it negotiated with the Obama Administration is getting relatively little ink.”

Boy, did I get a wrong number…

Trump already has heightened international tensions and he’s not even in office yet. His ill-advised phone call last week with Taiwan has deeply angered the island nation’s rival China, with the full consequences yet to pan out. Trump’s mouthpieces flocked to last Sunday’s political talk shows to downplay the destabilizing incident.

Meanwhile, President-elect Trump’s top military advisers are beating the war drums, with some even calling for “regime change” among volatile Middle Eastern countries.

Your best plays on these developments are the top U.S.-based aerospace/defense giants: Lockheed Martin (NYSE: LMT), Northrop Grumman (NYSE: NOC), Boeing (NYSE: BA), Raytheon (NYSE: RTN), and General Dynamics (NYSE: GD).

These blue-chip behemoths will benefit in 2017 and beyond from their entrenched relationships with the Pentagon establishment. Case in point: Ret. Gen. James Mattis, Trump’s pick for defense secretary, has close ties to General Dynamics.

The perpetual prophets of doom…

Speaking of global dangers, I got this query from a reader named Rick:

“What is your take on [the extreme pessimists] who are calling for a global economic collapse? Are they on to something or on something? I do believe it makes sense to have some of my assets outside the digital system and invested in precious metals, art or sitting in cash, but how much to allocate in that direction is the question. Thoughts as opposed to advice?”

Rick, the eternal doomsters are a tiresome bunch. These Chicken Littles constantly warn that the sky is falling, regardless of underlying fundamentals. Year in and year out, they hyperventilate about imminent catastrophe. Their real agenda is to capitalize on your fears.

But here’s the catch: the perma-bears aren’t always wrong. Sometimes they’re right, much the same way that a broken clock is accurate twice a day.

Credible, level-headed analysts are calling for a correction in 2017 that will usher in a prolonged down market. The bull market is more than seven years old; we’re due for a pullback. But you needn’t panic; there’s sufficient good news to keep you in the equity markets.

In the U.S., we’re enjoying accelerating gross domestic product growth, declining unemployment, and robust home prices. At the same time, rising oil prices are lifting the prospects of energy companies and the banks that lent them money.

Another bright spot for investors is the apparent end of the corporate earnings recession. According to research firm FactSet, the estimated earnings growth rate for the S&P 500 in the fourth quarter of 2016 is 3.3%. If this projection comes to pass, it would mark the first time the companies of the index have witnessed year-over-year growth in earnings for two consecutive quarters since Q4 2014 and Q1 2015.

The golden rule…

As for hedges against downturns, one rule of thumb is that your portfolio should hold 5%-10% in gold. We prefer gold miners to actual bullion.

If you own shares in a gold miner and the price of gold rises as expected over the next 12 months, the notion of “operating leverage” comes into effect. A bump in gold prices will likely give an exponential boost to a gold producer’s top line revenue. The gold producer’s earnings per share should go up and take the stock’s price with it, because the miner doesn’t have to sink a lot of additional labor or capital into digging out the increasingly valuable yellow metal.

The upshot: Don’t run for the exits; remain cautious and stick to quality. Your best bets are relatively safe growth plays, such as the aerospace/defense stocks mentioned above. And tune out the professional Cassandras. Listen to them and you’ll lose money.

Do you own gold as a hedge against the next downturn?  Let me know in an email: — John Persinos

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