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US DEFENSE

US DEFENSE – OF STALLED FY11 DEFENSE BUDGET – WHAT FUTURE US DEFENSE STOCKS?
By Howard Wheeldon, Senior Strategist at BGC Partners

22 Mar 11. With the 2011 fiscal year having begun on the first day of October last year it may come as something of a surprise to some that whilst hearings on the FY12 Department of Defense budget have already begun Congress is still arguing over both discretionary and non-discretionary aspects of the FY11 defense budget. Indeed, the White House, Republicans and Democrats are still at loggerheads on the overall US budget although objective opinion suggests that agreement is likely to have been reached by the latest April 8 deadline. We concentrate here predominantly on defense aspects of FY11 budget considerations and for what these and future defense budget pressures could mean for the defense industrial base. Our conclusion is that despite considerable effort by the Pentagon to rein back on defense spend, despite planned cut backs in armed forces personnel and of likely base closures in Europe and elsewhere, despite the intended pull back of actual US forces engaged with ISAF in Afghanistan and despite ongoing procurement cuts backs in legacy and some other new programs planned together with the potential to push some programs further back and in some cases, the scaling back of actual numbers of aircraft, helicopters, ships and ground support equipment likely to be procured over the coming years for the most part we believe that the change in budgetary stance related to overall defence procurement and RDT&E spend in the US will have little adverse direct consequence on the large defense primes over the next few years.

For the highly respected US Defense Secretary Robert Gates to be without a formal budget agreement and thus forced to work predominantly on a hand to mouth basis these must be very difficult times. Little wonder that faced with such impasse on the part of lawmakers and yet called upon to support US armed forces activity and support in various parts of the world that Mr. Gates should have indicated last Fall that he will retire at some point this year! On the potential retirement point our view remains that whilst we would much prefer that Mr. Gates would remain throughout the remaining period of this administration we are in little doubt that there are others well able to take on this hugely responsible job.

Back to the FY11 Defense budget that when first submitted [excluding overseas contingency operations] as a base budget request by the Department of Defense was just short of $549 billion. This represented a 3.4% increase over the enacted FY10 budget level. To be fair FY11 budget requests included $33bn for 2010 supplemental requests and some $159.3bn for 2011 to support ongoing overseas contingency operations. Indeed, it is probably worth mentioning that the actual $18.4bn increase over FY10 also includes plans to support defense acquisition reform and to develop a ballistic missile defense system. For FY12 the Pentagon which is after all the nation’s largest single employer proposed a budget of $670.6bn on a similar basis ($553bn for base budget spend and $117.8bn for overseas contingency operations).

Now well into the FY11 fiscal year with no agreement reached on the defense budget request yet not to mention continuing differences between Senate and House plans Secretary Gates is reliant on the basis of what are known on Capitol Hill as ‘continuing resolutions’. At the very least ‘continuing resolutions’ do just about allow the Pentagon to continue funding defence projects and general spend although if the basis was to continue through the whole fiscal year we reckon the actual funding shortfall would total close to $24bn making this a very sizable cut. The trouble is that it would not be a cut of course but similar to that which exists in the UK and is termed there as a deficit. The UK translation bears some degree of reality – in that case a £38bn overspend

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