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U.S. DEFENSE SPENDING TOPS OUT?

27 Oct 04. The FT reported that, “There never was a good war or a bad peace,” wrote Benjamin Franklin. Try telling that to US defence contractors. America’s military spending is running 50 per cent higher than in 2001. Not surprisingly, investors have pumped up the sector, especially since the start of the war in Iraq. Yet those same investors greeted last week’s mostly better-than-expected quarterly earnings from some defence companies with a distinct lack of enthusiasm. The biggest guns, including Lockheed Martin and Boeing, report this week.

One damper is that US defence spending may be topping out after three years of strong double-digit growth. The base budget for fiscal year 2005 (which began this month) is only about 5 per cent up on last year’s, although that may not be the final word. Defence is a priority in Washington and so unlikely to be a target for big cuts, whichever candidate wins the election. But both Republicans and Democrats are likely to try to keep a lid on increases in military spending which, at $437bn, made up about half of the amount the government classifies as discretionary outlays in fiscal 2004.

Uncertainty over the outcome of the election is another concern for investors – John Kerry has said he would spend more on troops and less on projects, such as missile defence, that directly benefit the big contractors.

With military revenues set to grow more slowly, some defence companies can look to civilian aviation as an alternative engine of growth. Honeywell, for example, reported third-quarter commercial aerospace sales up 17 per cent year-on-year, compared with just 3 per cent for defence aerospace. United Technologies also pointed to strengthening commercial aviation markets. Those two companies are active in upgrades and repairs to existing aircraft; stronger demand for new jets from the likes of Boeing could follow. Any business, though, is only as good as its customers. With many of the biggest US airlines in dire straits and high oil prices, there could be turbulence ahead in this market too.

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