Investment Contrarians

Huge Cuts Coming to This Market Sector, What This Means for Your Investments

By for Investment Contrarians |

Huge Cuts Coming to This Market SectorMarch 1 is a very big day for many people. Unless Obama and the Republicans make a deal prior to that date, billions of dollars in spending cuts will be enacted.

Of all the areas that will be hit, I think the defense market sector will bear the brunt of the cutbacks and the future viability of corporate earnings in this sector is certainly in doubt.

At this point, Pentagon officials are now planning for $46.0 billion in cuts for the remainder of 2013. The total amount to be cut in the military market sector is $1.2 trillion over the next decade. (Source: Nissenbaum, D., “Pentagon Readies Budget Ax,” The Wall Street Journal, February 11, 2013.)

The U.S. Department of Defense has already laid off approximately 46,000 part-time workers. We could see additional layoffs, as well as furloughs. There are thousands of other workers employed at private firms in the defense market sector that will be affected, as budget cuts will crimp corporate earnings.

Clearly, for the defense market sector, the future is cloudy at best. Corporate earnings for most companies throughout the defense market sector will have difficulty growing. When total revenues are declining, higher corporate earnings are extremely rare.

Unfortunately, this pain is actually needed for the long-term fiscal health of the country. While corporate earnings will be reduced and jobs will be lost in the defense market sector, continuing to spend such a massive amount of public funds in this area is irresponsible and clearly not warranted at this time.

Looking at 2011 data, the U.S. military spending was 41% of the total for the entire world. The U.S. spent five times as much on the defense market sector as China, and 95 times more than Iran. (Source: “World Military Spending,” Global Issues, last accessed February 13, 2013.)

Simply put, we can’t afford to spend money the way we did in the past; cuts need to be made. The defense market sector will just have to adjust to a lower level of corporate earnings.

This means investing in that market sector will be extremely difficult for the near future as corporate earnings start to stabilize at lower levels.

Lockheed Martin Corporation Chart

Chart courtesy of www.StockCharts.com

Lockheed Martin Corporation (NYSE/LMT) is already starting to see the effects from investors realizing that cuts in the defense market sector will become a reality. The reduced revenues will ultimately result in lower levels of corporate earnings.

The company does issue a large dividend yield, currently over five percent. With the payout ratio of approximately 50%, we will have to see exactly how the cuts in the defense market sector will impact corporate earnings and if a reduction in the dividend payout might need to be made.

This is a difficult time for the entire defense market sector, as well as the country. On the one hand, no one wants to see layoffs and reduced corporate earnings; on the other hand, the country needs to get its fiscal house in order. Considering how much of the budget military spending consumes, it certainly can’t be left untouched.

Investors in the defense market sector have a difficult road ahead. Cuts will certainly be a part of life for many years, most likely along with reduced levels of corporate earnings. While companies in this market sector currently issue strong dividend yields, these dividends could be in question over the next decade.

We will have to wait and see what sort of deal will be structured before coming to any conclusion.

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