Are aerospace and defense stocks vulnerable to a fiscal cliff sell-off? Investors might think so with all the rhetoric. I'm not so sure, and here's why.
We're told that going over the cliff will slash an unthinkable $1 trillion from defense spending. That is indeed the agreement, but few stories mention that this is a 10-year total reduction. According to the Congressional Budget Office, sequestration will reduce the Pentagon's baseline 2013 budget by only around $63 billion — less than 10 percent. This isn't chump change, but it's a long way from $1 trillion.
Another point to remember is that existing government contracts won't be changed by sequestration. Even the Pentagon has to honor its agreements once they are signed.
Where we will see some risk is in new contracts. As presently written, the law requires the cuts be made “across the board.” Certain segments, like military personnel, will likely be exempt from the axe. This means the remaining budget categories will bear more pain. (Actual war fighting should not be affected; operations in Afghanistan and elsewhere are funded separately.)
The defense cuts will add up to $1 trillion only if a) the sequestration hits in January and b) Congress leaves the budget alone for 10 more years. No one believes both will happen. The parties will reach some kind of agreement. New defense contracts might be delayed for a few weeks or months, but the Pentagon's long-term spending plans aren't likely to change.
Bottom line: The fiscal cliff's tax increases are a much greater concern than its spending cuts, at least for the defense sector. Aerospace and defense companies still have big growth potential overseas even if Washington cuts back. Don't let the screaming lobbyists tell you otherwise.
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