Since the war in Ukraine began, if not earlier, investors’ perceptions of the defense sector have changed for the better. Startups now play up, rather than hide, their military applications. (The Wall Street Journal)
NH: After the wind-down of the 9/11 Mideast wars, many U.S. companies distanced themselves from defense firms. They feared, with some justification, that "socially responsible" investors would balk at any connection to war.
And while, technically, ESG standards never excluded defense, many ESG funds avoided firms with large military sales. At bicoastal tech firms, CEOs also had to worry that their rising generation of Millennial employees would complain about or even boycott defense contracts.
Then something happened. Since the pandemic, much of that aversion has vanished.
Several trends have contributed to this shift. The first trend has been growing public worries about dangerous regimes abroad, their threat to global peace and human rights, and the need for American preparedness.
In the late 2010s, Americans' view of both Russia and China turned steeply in a negative direction. In 2017, for the first time, more than half of Americans favored U.S. military intervention in case South Korea or the (NATO) Baltic states were invaded.
In 2021, for the first time, they said the same for Taiwan. Both Democrats and Republicans participated in this opinion swing.
The second trend has been the partisan reaction to the increasingly isolationist flavor of Trump's populism before and after his 2020 electoral defeat. As president, Trump not only called for an unambiguous exit date on Afghanistan, but also threatened to pull U.S. troops out of Japan, South Korea, and Europe. What's more, he openly denigrated the courage and patriotism of U.S. military leaders--even of his own military appointees.
In response, almost as if by partisan instinct, Democrats on the left began to view the military as an institution again worth defending. If Trump suggests that the world's problems are not America's problems and that we should give more space and time to authoritarian leaders around the world, well, the Democrats will be increasingly prone to take a correspondingly anti-isolationist position. They will insist that America must remain committed to its alliances and engaged with the world.
From 2021 to 2022, according to Gallup, the share of Republicans who say they trust the military fell from 81% to 71% (-10pp). Meanwhile, the share of Democrats who say the same rose from 63% to 67% (+4pp).
So in just one year, the partisan trust gap fell from 18 points to just 4 points.
Ten years ago, a much smaller share of Democrats than Republicans agreed that America should "build strong relationships with our traditional allies (like South Korea and Japan)." Today, these shares are about the same.
The third trend--and the biggest game changer of all--has been the public reaction to Russia's invasion of Ukraine. Both Democrats and Republicans rallied overwhelmingly around America's need to send military assistance to Ukraine. The turnaround for Democrats has been especially head-spinning. An August 2022 poll found that a whopping 79% of Democrats still support "sending additional arms and weapons to the Ukrainian government."
For the first time in living memory, Democrats favor a U.S. military buildup against an authoritarian aggressor at least as much as Republicans--and are supported in this effort by every progressive social democracy in Western Europe. Earlier this week, The Atlantic announced "The Rise of the Liberal Hawks."
This shift has even seeped into the halls of Congress. Biden recently proposed increasing national defense spending by $30B.
In response, the House Armed Service Committee authorized an additional $37B above Biden's proposal. Fourteen of the committee's 31 Democrats voted with the Republicans for the increase.
Now that public attitudes toward military spending are changing, especially on the left, investor qualms about defense work is evaporating. The willingness of firms to be seen engaging and investing in defense work is following suit.
In February 2021, SEB, a Swedish financial group with $86B in assets, announced it would stop investing in defense and focus more on ESG portfolios. But in March 2022, it changed course. The company announced it would allow six out of its 100 funds to invest in defense businesses. According to a company spokesperson, its customers had a change of heart following Russia's invasion of Ukraine. What's so wrong with companies that defend democracy?
A similar shift occurred at Boom Supersonic, a Denver aerospace startup. The company is designing civilian airliners that transport passengers at speeds faster than sound. Previously, Boom had an agreement with the Air Force to transport U.S. diplomats. But the company's CEO made it clear he wasn't interested in further military ties. That all changed this July. Boom announced a partnership with Northrop Grumman (NOC) to help deploy military troops at supersonic speeds.
This year, defense stocks have fared better than the general market. The Dow Jones U.S. Aerospace & Defense Index is down only -3.88% YTD. In comparison, the S&P 500 is down -18.2%.
To be sure, defense stocks' better performance isn't just the result of changing attitudes. With the war in Ukraine ongoing and the Biden administration stepping up defense spending, there is simply more demand for defense technologies that is expected to continue.
Nevertheless, the evaporating stigma surrounding defense work is also helping to push up market demand for defense-sector equities, especially for the largest publicly traded tickers. What’s more, we're seeing this double-barreled shift abroad as well.
Since the invasion of Ukraine began in February, EU member states have pledged nearly €200B in increased defense spending. Goldman Sachs' index of European stocks with exposure to defense spending is up +58% so far this year, compared to a -13% decline for the benchmark STOXX Europe 600. Europe's embrace of the defense sector will further drive demand stateside.
How long will this more favorable investment climate for defense last? As we ponder this question, I can't help but draw a parallel between today and the pre-WWII era.
During most of the 1930s, the American public was highly isolationist, convinced that corrupt arms dealers had led the United States into the disaster of World War I--and determined never to repeat this mistake. While the mood was bipartisan, the New Deal left (especially the socialist-run national college student union) took the lead in opposing any foreign military intervention.
Then came the relentless march of global fascism: Japan's invasion of Manchuria (1933); Mussolini’s invasion of Ethiopia (1935); the Spanish Civil War (1936); Japan’s full invasion of China (1937); Hitler’s takeover of Austria and Czechoslovakia (1938); and finally Hitler's invasion of Poland (1939). Still, Congress insisted on enacting ever-tighter Neutrality Acts.
The isolationist mood finally broke in the fall of 1940, after Hitler's conquest of France and the beginning of the Battle of Britain. And the swing turned out to be much larger on the left than on the right.
Suddenly it was the New Deal Democrats (including the socialists) who most favored rearmament. If fascism was the new evil, the rearmament must be the new good. This left the Republicans, by default, as the leading isolationists.
From June 1940 on, Congress swung behind FDR's mission to turn America into "an arsenal of democracy." By the fall of 1941, even before the Pearl Harbor attack, a torrent of defense spending was at last lifting America out of the Great Depression—pushing up GDP at a blistering annual rate of 18% and bringing unemployment below 10% for the first time since 1929.
The rest, as they say, is history. What's instructive about this parallel is not that America's re-engagement with the world culminated in U.S. entry into World War II. What's instructive is how one political party, in this case the Democrats--that had for generations been strongly associated with isolationism (excluding Woodrow Wilson, of course)--could swing so massively the other way in such a short period of time.
Could the Democrats once again transform themselves from the party of isolationism and pacifism into the party of rearmament and global engagement?
It's possible. We've seen odder things before. If it does happen, and if the Democrats stay in power, that could transform the investment climate for defense for many years to come.
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ABOUT NEIL HOWE
Neil Howe is a renowned authority on generations and social change in America. An acclaimed bestselling author and speaker, he is the nation's leading thinker on today's generations—who they are, what motivates them, and how they will shape America's future.
A historian, economist, and demographer, Howe is also a recognized authority on global aging, long-term fiscal policy, and migration. He is a senior associate to the Center for Strategic and International Studies (CSIS) in Washington, D.C., where he helps direct the CSIS Global Aging Initiative.
Howe has written over a dozen books on generations, demographic change, and fiscal policy, many of them with William Strauss. Howe and Strauss' first book, Generations is a history of America told as a sequence of generational biographies. Vice President Al Gore called it "the most stimulating book on American history that I have ever read" and sent a copy to every member of Congress. Newt Gingrich called it "an intellectual tour de force." Of their book, The Fourth Turning, The Boston Globe wrote, "If Howe and Strauss are right, they will take their place among the great American prophets."
Howe and Strauss originally coined the term "Millennial Generation" in 1991, and wrote the pioneering book on this generation, Millennials Rising. His work has been featured frequently in the media, including USA Today, CNN, the New York Times, and CBS' 60 Minutes.
Previously, with Peter G. Peterson, Howe co-authored On Borrowed Time, a pioneering call for budgetary reform and The Graying of the Great Powers with Richard Jackson.
Howe received his B.A. at U.C. Berkeley and later earned graduate degrees in economics and history from Yale University.