As tensions rise in the Persian Gulf, several defense stocks may play to the current climate. To spot them, however, the first task is to determine the relative strength of the group, or, to use a relevant analogy -- see them from the view from 30,000 feet.
The S&P Select SPDR for Aerospace and Defense (XAR) has been on a tear this year, posting a 30.93% gain. The year-to-date figures use the base of a market that had crashed in December, so it can be somewhat misleading. But the one-year performance of XAR, an 18.88% gain, tells no lies. This sector is decidedly in favor, and thus it is unrealistic to expect to find hidden gems here.
But could an escalation between the U.S. and Iran into an actual shooting war rev this group up even further? Of course, and that's the move that traders want to consider.
Moving from the general to the specific, the U.S. drone that was allegedly downed by Iran Thursday over the Strait of Hormuz was an RQ-4A Global Hawk, manufactured by Northrop Grumman (NOC) . This drone reportedly carries an astronomical cost to the Department of Defense of $222 million per unit.
That said, the capabilities of this particular Unmanned Aerial Vehicle (UAV) are astounding, and the future of warfare is in unmanned smart equipment. I believe the "smartness" will come from the sensor systems, which in the case of the RQ-4A are produced by Raytheon (RTN) .
So, while my knowledge of aerial combat ranges only as far as repeated viewings of "Top Gun," I think Raytheon might be a better trade on UAVs than Northrop Grumman.
Also, remember that war-fighting requires high-spec equipment that has been vetted by national defense agencies over decades. Smaller UAV companies like AeroVironment (AVAV) and Kratos Defense & Security Solutions (KTOS) certainly have intriguing niches, but they just can't compete for contracts for UAVs that would power a conflict between military superpowers like the U.S. and Iran.
Not to be a swords-into-plowshares kind of guy, but reading about the enormous sensing and imaging technology that is included in the Global Hawk's payload made me think about another societal problem. Yes, I went back to my old days as a sell-side auto analyst, and asked, Why isn't this military technology being applied to self-driving cars, otherwise known as AVs?
Raytheon worked with Cadillac on a primitive thermal-imaging system called "Night Vision" that was introduced in 2000, but the company doesn't feature in any of my conversations with auto and tech executives on the future of AVs, nor does Northrop Grumman. It seems that the defense giants are ceding the market for imaging for AVs to companies such as FLIR Systems (FLIR) and Intel's (INTC) MobilEye.
So, the ability to move from a very niche market -- there are fewer than 100 Global Hawks actively deployed around the world -- to the more general market -- there are more than 1 billion cars on the road around the globe -- is just not there for defense contractors.
Government agencies are just so darn picky about intellectual property concerns. So, I don't consider either Northrop or Raytheon, which are trading at highs, as buy-and-holds. I don't own either name now. As we have learned this June, though, any stock can always go higher, and RTN and NOC are good conflict plays. In this incredibly toppy market, however, investors should not confuse trading opportunities with long-term holds.
