Defense Sector Worth A Closer Look [United Technologies Corporation, The Boeing Company, Lockheed Martin Corporation, General Dynamics Corporation]

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April 7, 2014 1:26pm NYSE:ITA NYSE:XAR

defense stocksRough trading to start 2014 is demonstrating that the easy upward slope of last year is likely a thing of the past. Correct sector selection will likely be needed to power gains this time around, especially given the recent worries regarding some of the former market leaders.

Companies in both the technology and biotech segments—which have been soaring and powering many portfolios for the past few months—have started to see some weakness in recent trading. While this could just be a temporary pull-back, it may also represent the beginning of the high beta name run and that other segments are due to take over leadership in the market.

New Sector Worth a Closer Look

One segment that investors definitely need to keep a closer eye on is the aerospace and defense sector. This industry currently has a Zacks Industry Rank in the top 5% and it is seeing some strong fundamental factors underpinning its lofty position too.

Obviously, one of the prime reasons for the renewed interest in the space is the rising tensions in Eastern Europe. A more aggressive Russia could spur Western countries in Europe to finally open up their pocketbooks and spend on defense to combat this new threat.

Meanwhile, concerns about reduced military spending back in the U.S. have pretty much been taken in stride by the sector. Most of the cuts look to hit personnel, saving many of the ‘big ticket’ items that several defense contractors see huge revenues from. This suggests that the budget issues will remain a non-factor for the space, at least in the near term.

And if that wasn’t all, the aerospace side of the equation is also looking quite promising too. Civilian demand for air travel is surging across the globe, and this is boosting demand for jets and related hardware, helping a number of companies in the sector which have huge operations in this corner of the market (read 3 Top Ranked ETFs that Will Crush the Market in 2014).

So overall, the sector is looking quite promising, and especially so given some of the outsized weakness in many of the high-flying names in other key sectors. Fortunately there are a few top ranked picks in this corner of the market, and we have described a few of our favorites below, any of which could be ready to take-off and lead the market higher in Q2:

Top Aerospace and Defense ETFs: 

SPDR S&P Aerospace & Defense ETF (NYSEARCA:XAR)

This is the cheapest choice in the aerospace and defense ETF market, charging investors just 35 basis points a year in fees for its exposure. The fund takes an equal weight approach, tracking the S&P Aerospace and Defense Select Industry Index, holding about three dozen stocks in its basket.

Due to its equal weight approach, no single stock comprises more than 3.7% of assets, leading to a very spread out profile. This also ensures that mid caps dominate the portfolio, as large cap stocks only account for one-third of the total assets in XAR.

The fund currently receives a top Zacks ETF Rank #1 (Strong Buy), and it could be an interesting choice for investors looking for a cheap, spread out play on this in-focus sector.

iShares US Aerospace and Defense ETF (NYSEARCA:ITA)

For investors seeking the most popular choice in the aerospace and defense ETF world, this iShares fund is definitely it. This cap-weighted fund tracks the Dow Jones US Select Aerospace and Defense Index, holding just under 40 stocks in its basket.

Unlike XAR, this product has a large cap focus, as big cap stocks make up more than 50% of the portfolio compared to roughly a quarter for mid caps. Familiar names like United Technologies (NYSE:UTX), Boeing (NYSE:BA), and Lockheed Martin (NYSE:LMT) take the top three spots, and together these three account for more than 23% of the total assets.

This fund also receives a Zacks ETF Rank #1 (Strong Buy), and it may be a top pick for investors seeking a global low risk play on this industry (see all the Top Ranked ETFs here).

Top Aerospace and Defense Stocks: 

Huntington Ingalls Industries (NYSE:HII)

If you are looking for more of a nautical play on the defense industry, consider HII. This company primarily builds, designs, and repairs ships for the U.S. Navy and the Coast Guard, ranging from nuclear-powered ships like aircraft carriers and subs, to amphibious assault vehicles and coastal defense ships.

HII has seen very strong positive earnings estimate revisions as of late, including universal agreement for both the current quarter and the current year. in fact, the current year consensus has soared from $6.22/share 30 days ago, to its level today at $7.04/share, suggesting that analysts believe a bright future is ahead for HII.

Thanks to these factors, HII currently has a Zacks Rank #1 (Strong Buy), meaning it could be primed for more growth in the months ahead.

Wesco Aircraft Holdings (NYSE:WAIR)

For a slightly different play on the aerospace segment, consider WAIR. This company specializes in supply chain management for a variety of aviation programs both in the military and civilian spheres. This niche could be a great one to be in as higher demand for a variety of planes and jets forces companies to become even more efficient in order to meet demanding customer needs.

WAIR has also seen rising earnings estimates as of late, and the company is looking for double digit earnings growth for both this year and next. Growth is actually expected to improve in the next year time frame compared to this year, meaning that WAIR may still have incredible potential.

Due to this, it shouldn’t be too surprising to note that WAIR has moved from a Zacks Rank #3 (Hold) up to a Zacks Rank #1 (Strong Buy) just this month, so it may be primed to see strong gains in the months ahead too (also read Best ETF Strategies for 2014).

Bottom Line

Markets have been choppy as of late and there is definitely some worry about sector rotation. Many of the high flyers—such as in biotechnology and social media—are starting to face a modest pull-back and concerns are growing that they are due for a correction too.

In light of this, it might be time to focus on a sector that is seeing rising earnings estimates, and is well positioned to benefit from current geopolitical realities. Aerospace and defense certainly fits this bill, and any of the aforementioned picks could be solid choices to play this trend in what is otherwise a very uncertain market environment.

This article is brought to you courtesy of Eric Dutram.

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