- The Washington Times - Monday, November 11, 2002

Republican victories on Election Day triggered a four-day rally among defense stocks last week, as investors anticipated quicker resolution on homeland security, and more congressional support for a bigger Pentagon budget and programs such as missile defense.
The Standard & Poor's Aerospace and Defense Index rose more than 11 points, or 6.1 percent, from Tuesday to Friday. Shares of Bethesda-based Lockheed Martin, the largest U.S. defense contractor, rose $6.20, or 12 percent, to close the week at $56.43. Shares of Falls Church-based General Dynamics rose $4.10, or 5.3 percent, to close the week at $81.60. Boeing, Raytheon and Northrop Grumman all saw sizable gains.
The rally last week restored defense stocks to levels not seen since early October. They had fallen gradually in the past month as some investors shifted their money to less-expensive stocks and others remained cautious, waiting to see whether Republicans would take control of Congress. Speculation that Democrats would remain in power caused some stocks to dip in the days before the elections.
To some analysts, a surge in defense stocks came as no surprise, given the strong support defense funding traditionally has received from Republicans.
"A GOP House and Senate is likely to make it easier for [President] Bush to push through higher defense spending," Banc of America Securities defense analyst Nick Fothergill said in a written recap of a conference call held Thursday. "Pet projects like missile defense should get an easier ride."
Mr. Fothergill said more Democratic victories on Election Day might have caused some second-guessing of congressional approval of action against Iraq.
"A Democrat win might have made the administration reconsider their hard-line stance on Saddam [Hussein]," he said.
Mr. Bush signed a $355.1 billion defense bill last month, which included the largest defense spending increase since 1982. He is expected to ask for as much as $400 billion for the 2004 budget.
But some analysts cautioned against getting too excited over the prospect of a defense buildup.
In a report released last week, Standard & Poor's senior analyst Robert Friedman argued that Congress is not likely to increase spending dramatically over the long term. He said a 2 percent to 4 percent annual defense budget increase is more realistic than the Pentagon's projection of a 5.9 percent annual increase over the next seven years. Furthermore, he said, defense stocks underperformed the S&P; 500 during the 1980s, a decade that featured a hefty defense buildup.
"Many in the investment community are counting on a combination of big, sustainable hikes in defense spending and the war on terror and possible strike on Iraq, and military weapons procurement reforms, to dramatically improve the industry's earnings and return on equity," Mr. Friedman wrote. "But we believe those optimists will ultimately be disappointed."
Mr. Friedman said that while most people view the 1980s as a decade of major defense buildup, spending grew significantly only during 1981 and 1982. After that, increases in defense spending were incrementally smaller, and defense budgets fell after 1985. He said other economic concerns could divert money from defense.
"We believe Congress will restrain such spending to take into account other budgetary concerns, such as sluggish growth in tax receipts, pressure for balanced budgets, social spending and homeland-defense initiatives," Mr. Friedman said.

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