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U.S. DEFENSE – WHAT HAPPENS NEXT

U.S. DEFENSE – WHAT HAPPENS NEXT
By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

04 Mar 13. With President Obama having now signed legislation that will see $85bn (£56bn) wiped off the FY2013 US Federal Budget eyes are now firmly turned on what happens next. To make matters even worse on March 27th the Continuing Resolution policy that Congress has been operating under also expires on. This adds the prospect that unless a new agreement emerges that raises the current $16.6 trillion debt ceiling the Government could – possibly by late May when it potentially runs out of cash – be forced into an almost total shutdown.

For those engaged in the US defense sector the next few weeks and months will be about deciding priorities, options and in the case of equity players, responding to shareholder concerns. For US politicians it may be a question of either keeping heads underground or regrouping. The weeks and months ahead are clearly going to be very difficult. Just as each and every UK defence stock was impacted through both the prospect and actual reality of MoD cuts so it is that each and every US defense stock will now be further impacted by whatever measure is decided by the Pentagon to cut spending. It is relatively easy for me to sum up the current US defense situation currently as an un-wholly mess – the worst in fact that I have ever seen in near thirty years as a defence analyst – but that will do nothing for those that will be most impacted by such wide scale cuts. Politicians will potentially rue the day that they allowed this to happen but despite the small prospect of political backlash over the next few weeks I see little prospect of the situation changing for the good unless ‘sequestration’ can be reversed in a couple of months time.

With sentiment on defense stocks already low and with further uncertainty over which individual programmes will be cut – specific decisions appear unlikely to be known before the early summer – the next three months are likely to see considerable volatility in US defense stocks. However, for the class of investor that may wish to be more opportune to the longer term and that decides to leverage on the back of potential geo-political events there could be some very interesting opportunities. Yield too should not be ignored. Worth remembering too that just because Congress has decided that substantial cuts to defense spend is now the order of the day will hardly force nations such as China, Russia, Turkey, North Korea, India, Iran and Mid-East nations that are currently dramatically increasing defence spend to change their minds. America will eventually see the potential risks of what they are doing to defense and reverse this but I guess not before they have destroyed a few more important bridges! Perhaps the classic term – events; events; may yet be remembered here!

While there is little if any good news to be observed from the current situation the next few weeks will show what if any further political backlash is likely to appear in relation to the proposition of such high sided cuts in US defense expenditure. Harsh is a word that I rarely use but with the proposition that FY13 could see $46bn wiped off the defense budget (note that for FY2013 the President had last year requested a total $525.4bn base budget for the Department of Defense spend and $533.6bn for FY2014) and up to $60bn in the years thereafter up to 2020 – the word is very appropriate here. Whilst a political backlash could yet sever the moment and clash heads together I somehow doubt that it would be wise to envisage change to a rather in-ordely process of cuts that the President has already signed into legislation.

In terms of which defense programmes might be most at risk my US colleagues continue to point me in the direction of expecting that in terms of airpower priority programmes such as the KC-135 tanker refuelling programme and the planned Long Range Strike Bomber replacement prog

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