Military Preparedness

by Jeffrey Saut of Raymond James, 5/14/18

Today, we revisit the military preparedness question following President Trump’s nearly $700 billion military budget to attempt to make our military readiness better. We think the recent weakness in the defense sector stocks provides an interesting entry spot for investors. Indeed, many of the defense stocks have collapsed since their mid-April all-time highs. Concurrently, the iShares U.S. Aerospace & Defense ETF (ITA/$198.47) has pulled back. Believe it or not, the defense stocks are not just, well defense stocks, but technology stocks, as well. Take Lockheed Martin’s secretive Skunk Works division. As Wikipedia writes:

Skunk Works is an official pseudonym for Lockheed Martin’s Advanced Development Programs (ADP). It is responsible for a number of famous aircraft designs, including the U-2, the Lockheed SR-71 Blackbird, the Lockheed F-117 Nighthawk, Lockheed Martin F-22 Raptor, and the Lockheed Martin F-35 Lightning II, which are used in the air forces of several countries. The designation “skunk works” is widely used in business, engineering, and technical fields to describe a group within an organization given a high degree of autonomy and unhampered by bureaucracy, with the task of working on advanced or secret projects.

Pretty much for this entire nine-year bull market, we have favored Technology and considered the defense stocks to be technology stocks “in drag” with many of them selling at cheaper valuation metrics than the best known tech stocks. The other sector we have really liked is the Financial sector. To that point, we recently met with Anton Schutz, the portfolio manager of the RMB Mendon Financial Services Fund (RMBKX/$46.70). We met him at the Ocean Reef Club near the top of the Florida Keys. After spending a few days with him, and swapping stock ideas, we became very impressed with his investment model. His fund seeks capital appreciation and pursues that goal by investing at least 80% of net assets in the common stocks of U.S. companies in the financial services sector, but primarily in small capitalization stocks (an under-owned space). Anton invests in companies with strong management teams, sound financial practices, and a defensible business niche. His focus is on firms with sustainable growth in earnings and revenue and strong cash flows and in identifying undervalued equities that are temporarily distressed and, therefore, have merger and acquisition potential. As a sidebar, Anton is friends with our pal David Ellison who manages the Hennessy Small Cap Financial Fund (HSFNX/$24.99), which I own. In the current market cycle, we like the “small-cap” space for numerous reasons and would note that the S&P Small Cap 600 traded to new all-time highs last week.

Moving on to the stock market, the most important chart of last week is the Cumulative Advance/Decline Line chart, which made new highs (Chart 1 on page 2). As Bespoke Investment Group writes:

One of the most bullish aspects of the market throughout the sell-off from the January highs right up through Friday has been the S&P 500’s cumulative A/D line. We’ve highlighted the strength in this indicator a number of times in the last three to four months, but as the chart illustrates, since the S&P 500’s peak in late January, the cumulative A/D line has made three new highs now.