Financial Myths: “The Guns, Thank God, The Guns” — Part I

Michael McTague |

The US overall defense budget for 2017 stands at $834 billion, which includes $603 billion for military costs, $175 billion for Veterans spending and $56 billion for foreign policy and foreign aid, according to USGovernmentSpending.com, overall defense spending runs from about 3 to 5% of Gross Domestic Product (GDP).

The Myth Buster’s purpose is to look at this sizeable part of the American economy by scouring facts and figures and drawing conclusions. Politics is not the focus. The decades have seen a steady decline in the number of active military except for periods of military conflict. For example, in 2014, about 1.4 million military personnel served in the US, but in 1960, the number was 2.5 million.

The general view is that only one superpower exists, and, while military threats persist, the likelihood of another World War remains remote. Hence, military spending does not rank as the most significant issue facing the nation. In fact, according to a Pew Research study for 2015, the military ranked eleventh in a list of 23 compelling issues. However, terrorism ranked first on the survey, so military spending retains a place of significance.

Piecing together the information above along with a few lessons from history – the Grand Armada and World War II, for example -- justifies a conclusion: it isn’t so much a matter of the size of the military that counts (size measured by number of people in uniform), but the power of technology. An active military of 1.5 million is quite formidable, but much more goes into making the US a superpower. According to The Infographics Show, the number one military priority at this time is the F-35 Lightning II, the new fifth-generation stealth fighter to be used by the Navy, Air Force and Marines. The website states that this technological leap may cost $1.5 trillion dollars. From a business point of view, the capability must be superior to any other and both the technology and the funding must be found to produce this military sensation.

The new Columbia Class Ballistic Missile Submarine ranks third on the list. This neo Star Wars weapon is designed to replace the Navy Submarine Based Nuclear Missiles from the current Ohio Class Submarine. It won’t be ready until 2031 and may cost $100 billion dollars to roll out along with $100 million dollars per year per submarine to maintain.



Stealth Rules

In defending a massive country, stealth is the key word. Nuclear-powered ballistic missile submarines, called SSBNs for short, perform a specialized mission of strategic nuclear deterrence. Firing from beneath the ocean, SSBNs launch their projectiles armed with multiple nuclear warheads. They employ large-diameter vertical launch tubes located in the middle section of the ship. The SSBNs’ task is to remain hidden at sea but ready to strike quickly and effectively. They are able to deter a nuclear attack because of their powerful second-strike capability. Deals will be made, budgets will be drawn up and revised. In the end, these two hugely expensive and militarily powerful priorities will emerge as part of the human and technological defense of the US.

While these systems operate by stealth, their cost and manufacture are public. Several American companies will be busy. Electric Boat, a division of General Dynamics (GD), will be fast at work as well as Lockheed Martin (LMT) and Northrup Grumman (NOC). Not surprisingly, their stocks show strong investor interest. General Dynamics’ share price is up about 47% over the last year. Lockheed Martin has shot up 19% during the twelve month period and now commands a market capitalization of about $82 billion. Not to be outdone, Northrup Grumman rose 21% and its market cap stands at $45 billion.

Technology Dominates

The emphasis is clearly on technology. New technology of this kind is very expensive, which leads to two observations. First, “The Guns,” to use the words of the myth, may be more important – or at least more destructive – than the people using them. Individual bravery is an extraordinary achievement, but the capability of individuals lags the sheer power and force of modern weapons. This places more importance on developing and maintaining such weapons than on training members of the military. Some years ago, the Myth Buster interviewed the captain of the USS Vincennes and spoke to some of the crew members. Several joked that most people do not have a clear idea of what “Star Wars” really means. The crew said that with modern technology, you can shoot at someone half way around the world. These new weapons can do that and with awesome power.

Second, defense is very expensive and requires great capability in the firms producing such weapons. Working with a technology research company, the Myth Buster learned that today’s stealth fighters project a radar image the size of a bumble bee. Not bad for a plane that weighs about 25,000 pounds! Judging by a morning commute, most people are occupied 24/7/352 by texting while walking, surfing for really cheap sweatshirts and checking the cost of online delivery. However, the technological work at the large defense manufacturers makes a strong case for its hegemony and for a long-standing presence in the economy.

It appears that Rudyard Kipling was onto something in his line about the guns. Technology has often made the difference between winning and losing. Boeing (BA), Ratheon (RTN) and BAE Systems (BAESY) also play a huge role in this massive industry. In the next installment, we will look more deeply into this complex and sizeable matter.

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Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
LMT Lockheed Martin Corporation 316.55 1.90 0.60 146,944 Trade
RTN Raytheon Company 184.91 1.03 0.56 229,539 Trade
GD General Dynamics Corp. 198.96 0.22 0.11 253,528 Trade
NOC Northrop Grumman Corporation 302.58 1.64 0.54 78,131 Trade
BA Boeing Company (The) 265.59 0.96 0.36 424,675 Trade
BAESY BAE Systems Plc ADR (Sponsored) 29.19 -0.06 -0.21 34,604

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