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Aerospace & Defense ETFs In Focus On China, U.S. Budget

Mon, Feb 1, 10:36 AM ET, by Michael Johnston

After staging an impressive recovery in 2009 to claw back significant losses incurred during the recent recession, the aerospace and defense sector has hit a few speed bumps early in 2010, as potentially negative developments both home and abroad threaten to sap demand.

“Gross Intervention” In China

Last week, China announced the suspension of military exchanges with the U.S. as a response to a $6.4 billion sale of weapons to Taiwan. In addition to threatening to destabilize relations between the two superpowers, the move could also harm U.S. industry. Calling the arms sale “a gross intervention into China’s internal affairs,” China will also impose sanctions on U.S. companies involved in the sale.

In accordance with the Taiwan Relations Act, the U.S. is obligated to provide Taiwan with “arms of a defensive character,” but similar actions in the past have enraged China, which claims Taiwan as part of its territory. It remains unclear how many U.S. companies could be sanctioned or how severe the impact of such sanctions could be. After a separate arms sale to Taiwan in 2008, China suspended military exchanges for about six months.

Cuts At NASA

As expected, President Obama’s budget released on Monday included proposals to save about $250 billion by imposing a three-year freeze on discretionary spending starting in 2011. The budget identifies 120 federal programs to curb, including NASA’s Constellation project aimed at returning an American to the moon by 2020 and building a manned base there. While Obama is proposing modest increases to NASA’s nearly $20 billion budget, the extra $1 billion per year isn’t nearly enough to keep the Constellation program going. It is likely that the new rockets will be scrapped, even though $9 billion has already been spent on their development.

The ultimate impact of the budget freeze isn’t immediately clear. While a reduced budget for NASA is obviously a negative development for companies that do business with the agency, the announcement did come with a silver lining. The administration announced incentives for private companies to develop commercial rockets capable of flying astronauts to the International Space Station in low-Earth orbit.

Aerospace & Defense ETFs In Focus

For investors looking to make a play on the aerospace and defense sector, there are a couple of ETF options available. While both of these funds are perhaps more sensitive to demand for commercial aircraft from the global transportation industry, several component companies will likely see their operations impacted by the recent developments discussed above as well.

  • iShares Dow Jones U.S. Aerospace & Defense Index Fund (ITA): This ETF is linked to an index that measures the performance of aerospace companies (including manufacturers and assemblers of aircraft and aircraft parts) and defense stocks (producers of components and equipment for the defense industry). ITA has about 32 holdings, including Boeing, Lockheed Martin, and Northrop Grumman, and charges an expense ratio of 0.48%.

ITA

  • PowerShares Aerospace & Defense Portfolio (PPA): Based on the SPADE Defense Index, this ETF has significant overlap in holdings with ITA, including many of the top ten holdings. PPA offers much more depth of holdings (about 57 component stocks) with a slightly higher price tag (expense ratio of 0.60%).

PPA

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Disclosure: No positions at time of writing.


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