6 Picks To Ride The Global Defense Boom

Tony Sagami

With all the turmoil in the Middle East, it was easy to overlook last week’s stunning announcement from the Chinese government.

China announced that it was increasing its military and defense budget by 12.7% to an estimated $91.5 billion, which amounts to 1.4% of gross domestic product.

To put that number into perspective, India spends about 2% of its GDP on defense while the U.S. budget of $725 billion in 2010 translates into about 4% of GDP.

Now, $91.5 billion is a mountain of money, but most military experts think China is spending a lot more than that. Regardless of what the true number is, China is on a path to become the world’s most powerful military.

Other than 2010, when defense spending was up by 7.5%, China has been increasing its military budget by double-digits for most of the last decade.

China swears that its military might is purely for self-defense: “The limited military strength of China is solely for safeguarding its national sovereignty and territorial integrity and would not pose a threat to any country,” said Li Zhaoxing of the National People’s Congress.

Why is it that at the same time China has been gearing up its military, it has increasingly become more belligerent with its Asian neighbors, particularly to assert its claims to the vast (and oil rich) area of the South China Sea?

Last fall, China increased its presence in the South China Sea after Japan detained a Chinese fishing boat captain after his trawler bumped into two Japanese patrol boats near a disputed area.
Then, a Filipino ship in the South China Sea complained of being harassed by Chinese patrol boats near the Spratly Islands, a small chain that’s rich in resources and claimed by the Philippines, China, as well as other nations.

Here are some of new Chinese military developments that are keeping U.S. Generals awake at night:

AIR FORCE: In January, China confirmed it had held its first test flight of the J-20 stealth fighter that it was happy to show off during a recent visit by U.S. Defense Secretary Robert Gates. The J-20, a rival to Lockheed Martin’s F-22 Raptor, is capable of evading detection by enemy radar.

NAVY: China is on schedule to launch its first aircraft carrier this year, which will make it the most powerful maritime fleet in Asia. An aircraft carrier is estimated to cost $2 billion to build, and China has two of them in the pipeline. Plus, China is building a new fleet of “Jin-class” ballistic missile submarines, capable of launching nuclear warheads while at sea.

ARMY: China’s People’s Liberation Army has about 2.3 million soldiers, the largest standing army in the world.

MISSILES: China has developed some of the most sophisticated missile technology in the world. China has successfully developed missiles that can knock enemy missiles out of the sky and has a nuclear arsenal of 100 to 400 intercontinental ballistic missiles as well as land- and submarine-based missiles.

The Pentagon says China has the most active land-based ballistic and cruise missile program in the world, and that it is “developing and testing several new classes and variants of offensive missiles, forming additional missile units, qualitatively upgrading certain missile systems, and developing methods to counter ballistic missile defenses.”

How advanced? China has about 130 land-based ballistic missiles that can carry nuclear warheads as far as 13,000 kilometers — powerful enough to reach the United States.

China’s nuclear arsenal is small compared to the U.S. arsenal, which has 5,113 active nuclear warheads. Russia is thought to have a similar number, while France and Great Britain have fewer than 300 warheads.

No wonder Japan, India, Taiwan, South Korea and Pakistan have been hiking their defense budgets to build up their military.

Clearly, the military is big business in Asia, and that translates into opportunity for investors. The bad news for U.S. investors is that there isn’t any DIRECT way to invest in the Chinese military buildup. There are, however, lots of backdoor and ancillary ways to invest in the global defense boom.

And when it comes to military and defense suppliers, the United States is second to none.

There are two defense exchange-traded funds to consider: PowerShares Aerospace & Defense (PPA) or Dow Jones U.S. Aerospace & Defense (ITA). Both funds have substantially similar holdings and include companies such as United Technologies, Boeing, Lockheed Martin, General Dynamics, Raytheon, Precision Castparts, Northrop Grumman, and Rockwell Collins.

There are dozens of second-tier specialty defense stocks that should benefit from the military spending boom:

Ceradyne (CRDN) makes specialty ceramics used for industrial, commercial, and automotive applications but also in lightweight body armor and helmets.

GenCorp (GY) is a pioneer in the development of propulsion system technologies that are used in missiles, maneuvering systems, spacecraft and satellites.

Elbit Systems (ESLT) supplies defense electronics for the F-15 and F-16 fighters, the Comanche helicopter, the Bradley Fighting Vehicle, and other military vehicles.

Force Protection (FRPT) makes armored vehicles that protect their occupants from landmines, hostile fire, and improvised explosive devices (IEDs).

Now, I am not suggesting that you rush out and buy any of these ETFs or stocks tomorrow morning. As always, timing is everything so you should wait for them to go on sale before jumping on board. And don’t forget to do your own homework to make sure that any securities mentioned in this column are appropriate for your personal financial goals and tolerance for risk.

The world is becoming a more hostile place to live, and there are big profits to be made by making the world a safer place to live.

Best wishes,

Tony


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Posted 03-11-2011 10:23 AM by Tony Sagami
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