Aerospace/Defense ETFs Back in Vogue, But Caution Warranted

Amid a new war in the Gaza Strip and with Russia’s invasion of Ukraine close to starting a third year, aerospace and defense stocks and exchange traded funds are back in the spotlight.

Just look at the Dow Jones U.S. Select Aerospace & Defense Index. That widely observed gauge is higher by 6.37% over the past week, confirming that geopolitical conflict often prompts investors to rapidly revisit defense stocks. That response is logical, but logic aside, market participants should be careful about scurrying into aerospace and defense stocks and funds after news is priced into these assets.

After all, the old saying “buy the rumor, sell the news” exists for a reason. Add to that, there are no guarantees that short-term events will materially alter the fundamental trajectory of this industry.

“First, there’s the idea that combat today leads to more future purchases of weapons manufactured by a given firm, making that company’s stock worth more,” according to Morningstar research. “This ignores how long in advance militaries procure weapons, and how they’re subject to strategic and political constraints. Second, there’s the broader narrative that sudden fighting in a geopolitical hot spot increases instability and defense budgets, and thus defense contractor revenue. This is more logically sound, but after the U.S. defense strategy pivot to great-power rivalry in 2017 and Russia’s invasion of Ukraine in 2022, we don’t see incremental upside to global defense spending.”

On the other hand, the following aerospace and defense ETFs could be worth considering by long-term investors.

Invesco Aerospace & Defense ETF (PPA)

The Invesco Aerospace & Defense ETF (PPA), which  follows the SPADE™ Defense Index, is one of the oldest and largest ETFs in this category and it’s chock full of many of the most familiar large-cap names from this industry. PPA is proving responsive to Israel defending itself against Hamas terrorists as highlighted by the ETF’s 6.43% jump over the past week.

While geopolitical conflict can power aerospace ETFs to short-term gains, Israel moving to protect itself against a terrorist organization could spur passage of the fiscal 2024 defense spending bill, which could have longer-ranging implications for PPA and peers.

“From the perspective of the DoD budget, the events over the last few days likely provide a smoother path to seeing a 2024 DoD budget done before year-end, and one which either explicitly bypasses spending  caps, or provides emergency funding/supplements that indirectly bypass them,” observes Deutsche Bank’s Scott Deuschle. “This is a clear positive for the entire sector, and meaningfully weakens the bear case on defense,  which was heavily contingent on slowing DoD budget growth.”

ARK Space Exploration & Innovation ETF (ARKX)

The ARK Space Exploration & Innovation ETF (ARKX) shouldn’t be overlooked in the aerospace and defense ETF conversation because aerospace is at the center of space exploration and the related investment thesis.

While ARKX lacks the defense  purity found in ETFs such as PPA, the ARK fund is home to several pure-play defense stocks. Moreover, the space investing thesis is taking shape and could offer patient investors access to exponential long-term growth.

“Space is cheap now. Operators can get to space and it’s not just nation states, it’s now private companies — that’s a huge change in the paradigm,” said Duane Freer, manager of the FAA’s Air Traffic Organization Space Operations office, in a CNBC report. ““We’ve made significant strides in lessening the impact and managing the airspace much more efficiently for launch and reentry missions,” Freer added. “It wasn’t that long ago that SpaceX was a new company and these were all notional ideas.”

Global X Defense Tech ETF (SHLD)

Having debuted last month, the Global X Defense Tech ETF (SHLD) is one of the newest additions to the aerospace and defense ETF fray. It’s also arguably one of the most pertinent because it marries disruptive technology with an industry that has under-appreciated high-tech credentials.

SHLD’s 34 holdings are “companies that build and manage cybersecurity systems, utilize artificial intelligence and big data, and build advanced military systems and hardware such as robotics, fuel systems, and aircrafts for defense applications,” according to Global X.

All of SHLD’s holdings are industrial or tech stocks, but the ETF tilts heavily toward the former sector, explaining why its earnings multiples are attractive at the moment.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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