SUMMARY
Policy risks are concentrated in geoeconomics as summer 2022 nears an end. Three quarters ago geopolitics vied with economic policy on the list of macro overhangs. Ex-Russia, geopolitics are adjusting to a series of global shocks which leave risks elevated but no longer rising, in our view. Dislocations to global agriculture and energy markets still feed inflation, and European migration policy is under renewed political pressure (related to Brexit and war fallouts). The more discernible near-term investment theme from geopolitics remains the transatlantic uptick in defense spending.
Defense Spending Remains a Bright Spot
Geopolitical risks are always numerous, and one should never minimize surprises developing from unknown risks, but outside of the Russia-Ukraine war geopolitics is less threatening than three quarters ago. Part of our thesis is that G2 tensions are more easily managed than China’s current economic challenges, with Taiwan serving as a useful example. It helps that the Chinese and US militaries are among the more professional in the world, especially when juxtaposed to Russia’s.
The S&P is off 13% YTD, but four of the top five defense names have outperformed the index, and sustained US defense spending is one factor. Boeing (BA) is the underperformer having given back 20% since the first trading day of January 2022. The other four have had a good year: RTX (+8%), GD (+12%), LMT (+22%), and NOC is up 25.5%. We’re grateful, again, to John Roque for helping set our thinking straight.
We believe September and December are the next two periods to watch for defense spending for directional signals. The Senate will next month complete consideration of the FY23 National Defense Authorization Act (the House passed a bill last month which boosted some defense names based on an overall authorized 8% yoy funding increase). We believe the Senate will either match or fall a point short of the proposed House increase.
A continuing resolution Congress very likely will pass before the October 1 fiscal year 2023 start. The CR won’t provide new money just a carryover of the existing FY22 funding levels. New FY23 appropriations that will include an increase in defense spending are likely in a December omnibus bill for the three quarters remaining in that fiscal year.
Moreover, the White House announcement earlier this week of an additional $3 billion to Ukraine supports the procurement replenishment story likely to play out through 2023. This will bring US military and logistics support for Ukraine to $14.5 billion in the six months since the war began. US support for Ukraine for now seems very likely to last as long as Putin’s invasion.
US fiscal policy is unlikely to present investor risks until next summer when the debt ceiling will need tending. Monetary policy until then will command macroeconomic policy risk uncertainties as central banks fight inflation, and the PBOC attempts to carefully stimulate China’s GDP. Chair Powell on Friday will underscore the policy risk importance of monetary decisions, even if one allows for nuanced messaging but likely very clear actions this fall.
