Monday, January 22, 2007

Chinese anti-satellite missile test/iShares aerospace and defense ETF

While political pundits were occupying themselves with “to surge or not to surge” and the Dem’s first 100 hrs in congress, the news that China successfully tested an anti-satellite missile by blowing up one of its aging weather satellites almost slipped through the news cycle. This CNN report contains a video link. My impression of the very short clip from the press conference was that Tony Snow was wishing the whole thing would just go away. For some reason, the test was conducted on Jan. 11, and the main stream media did not pick it up until Jan. 19.

Of course, one ought not be surprised, since Russia and China (for that matter the whole international community) has been trying to get US to sign a ban on space-based weapons for some time. It is also common knowledge that US is the undisputed leader in this area even after this latest Chinese advance. Some might characterize this move by China as a ploy to get US back to the negotiation table, but any realist could see that a space arms race, which has long been going on behind the scenes, is inevitable. Space, as they say, is the final frontier.

This is not to assign blame to anyone, for we are squarely in the realm of “real politik”. It’s a classic prisoner’s dilemma situation where nothing good will ensue. A new international agreement, even if signed, will only slow down the arms race in the best case, just as the nuclear test ban treaty simply moved testing to a digital platform. At any rate, we have to realize that satellites directly above someone else’s territory are indefensible. More fundamentally, US’s hegemonic power is predicated upon a monumental overspending which cannot be maintained when the object of subjugation is a rising industrial power with 1 trillion in reserves.

Alright, enough of being fatalistic. I accept the reality of the world we’re living in, and it behooves to position myself the best way I can. So I’ll make the case for investing in the defense industry here. A space arms race, however irrational and unwinnable, is sure to booster the aerospace and defense industry into the “low earth orbit”.

From Jeffery Saut
The basic premise was already strong prior to this latest incident. Following is from a Jeffery Saut missive dated December 26, 2006. It’s no longer available at the Raymond James site but here’s the Google cache page.

This is the interesting bit:

Having lived around “The Beltway,” we have a pretty decent sense for how the political winds blow. Last week’s visit to “The Hill,” however, surprised us. Indeed, we arrived thinking that political gridlock was likely to be the course over the next few years, but that sense changed after a few conversations. Surprisingly, we found many of our Republican and Democratic leaders pretty much in agreement on numerous things. Of particular note was a near unanimous agreement between the Congressional folks from states devastated by companies moving jobs offshore. While said Congressmen can’t force companies to keep jobs in their states, one thing they can do is vote for an increase in the defense budget and mandate that those attendant high-paying jobs be kept in the United States. The last time such a defense build-up occurred was during the Reagan years and it led to a BOOM in economic activity punctuated by near 8% GDP growth. And maybe, just maybe, that is what the stock market is “seeing.” The quid pro quo is that such a boom would obviously be accompanied by more rate ratchets from the Fed . . . aka, “the fooler.”

I think the message was crystal clear. He went on to suggest two ETFs for this sector: iShares Aerospace & Defense Index (ITA) and the PowerShares Aerospace & Defense Portfolio (PPA).

ITA vs. PPA
ITA tracks the Dow Jones aerospace and defense index (components) whereas PPA tracks PowerShares’ proprietary SPADE™ defense index. The main difference seems to be that PPA contains some consumer discretionary names like DirectTV and EchoStar, as well as some IT names related to biometrics and homeland security. ITA was just introduced last May. Over its short life, PPA has outperformed slightly. ITA has an expense ratio of 0.48% vs. 0.60% for PPA. I personally gravitated towards the former but both capture the desired exposure well. Daily dollar volume is equally low at $1.5-2 million. ITA trades only about 30k shares; however, I have noticed persistent 30 lot orders with a bid/ask spread of 4 cents. I’m not sure if there is a market maker providing liquidity. Perhaps a more knowledgeable reader can shed some light here.

Technical Picture
On the daily chart ITA just completed a breakout and a retest of the $54 level. One may ask whether this is a late stage breakout, but the benefit of the doubt resides with the trend until proven otherwise. As long as it stays above $53, I’m not going to fret much.

The long term DJUSAE vs. S&P chart makes a very convincing case for this sector. In fact, it can be argued that we’re at the brink of a new leg up and this latest incident could very well be the catalyst.

Disclosure: I’m long ITA and all the usual disclaimers apply.