What’s Next for Aerospace and Defense?

The aerospace and defense (A&D) industry has captured investors' attention following President Trump’s election, rising geopolitical tension, and potential tax reform. Many of the A&D industry’s fundamental drivers have been in place long before these recent developments. However, these recent developments may offer upside optionality yet are not solely reliant on political outcomes. A steady improvement in existing long-term fundamentals and new fundamental catalysts, in addition to policy developments, may warrant a closer look by investors

Aerospace and defense led markets sharply higher following Trump’s election and the idea of fiscal stimulus – lower taxes, higher defense spending - it ostensibly promised. However, as political headwinds continued to mount this year, markets began to price out fiscal stimulus and “Trump Trade” began to unwind, leaving many advisors to ask, “What now?” Investors may want to consider the following:

  1. Longer cycles, more growth potential
  2. New buyers
  3. Shifting line items in the DoD budget
  4. Valuations may have room to run
  5. Aerospace & defense relative performance

Aerospace & defense relative performance

Aerospace & defense relative performance

Source: Thomson Reuters, as of October 26th, 2017. The indexes shown are the Dow Jones U.S. Select Aerospace & Defense Index relative to the S&P 500. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.


Airline service has deservedly gotten a bad rap, but we believe the aerospace industry has a lot going for it. The sector can be divided into two segments, original equipment manufacturers (OEMs) and industry suppliers. Overall, the sector has grown faster than nominal GDP, has maintained consistent pricing, and has kept new entrants at bay with highly technical intellectual property.

Longer cycles, more growth potential: OEMs have benefitted from a long, secular growth trend since the 1980s. While OEM growth cycles have historically been short and sharp in magnitude, they have lengthened over time. Indeed, since 9/11 the industry has been in a ‘super cycle,’ as aircraft shortages, emphasis on fuel efficiency, and the rise of new emerging and low-cost air carriers have driven orders. Large backlogs at OEMs have continued to grow (albeit at a slower pace). Meanwhile, suppliers’ returns have consistently outpaced even OEMs due to higher aftermarket content for used parts, lower upfront investment, and lower program risks. Although aftermarket growth has slowed to high single digits, it has continued to track nominal GDP. What’s more, global traffic, measured as revenue passenger mile (RPM), has grown about twice as fast as nominal GDP over the past 40 years.1

New buyers: The mix of air traffic has shifted dramatically in recent years towards regional carriers in the developing world, particularly Asia and the Middle East, where they serve a rising middle class. In 2000, the U.S. and Europe accounted for 65% of the 2 trillion in global RPM. By 2025, the U.S. and Europe are estimated to account for just 44% of the 5.1 trillion in global RPM.2