We Need More Ammo—and Fast

Below is a complimentary Demography Unplugged research note written by Hedgeye Demography analyst Neil Howe. Click here to learn more and subscribe.

NH: Last week, the Biden administration announced a new $625M security assistance package for Ukraine that includes additional arms, ammunition, and equipment from Department of Defense inventories.

This is the 22nd time that the administration has authorized military aid to Ukraine and brings the total amount of assistance the United States has pledged to over $17.5B since 2020.

The latest package includes four High Mobility Artillery Rocket Systems (HIMARS), which have become a prized tool in Ukraine’s ability to destroy bridges, command posts, and supply depots way behind Russian front lines. This ups the total number of HIMARS sent to Ukraine to 20.

Earlier, in mid-September, the Pentagon pledged to send another 18 HIMARS to the country --but unlike the original 20, these don’t exist yet. They will be ordered from the manufacturer, Lockheed Martin (LMT), and are expected to take “a few years” to deliver. I guess we just have to hope that Ukraine is still around by then to take delivery!

This two-pronged approach (shipping inventory now and ordering more for later) illustrates the quandary the U.S. military faces.

The United States has provided by far the most aid of any country to Ukraine and is trying to continue its support without jeopardizing its own military readiness. Defense officials warn that certain supplies are already running dangerously low. Committing to new manufacturing shows that we’re in it for the long haul--but that, of course, doesn’t help Ukraine stave off Russia’s advances today.

The war has depleted American stockpiles at eye-popping rates. The normal production level for ammunition for the 155 millimeter howitzer--a heavy-artillery weapon that can strike targets just over a dozen miles away--is about 30K per year during peacetime.

According to one estimate, the Ukrainian soldiers go through this amount in roughly two weeks. As of August 24, the United States has provided Ukraine with 806K rounds, or nearly 30 years’ worth of production. In a sign that officials are concerned about a potential shortage, they have increasingly supplied Ukraine with older, shorter-range 105 mm howitzers and their ammunition instead.

Another weapon that has been critical to Ukraine’s offensive is the Javelin, an anti-tank missile manufactured by Raytheon (RTX) and Lockheed Martin.

The United States is estimated to have had 20K to 25K Javelins in inventory when Ukraine was invaded. We have since sent more than 8.5K of these to Ukraine. Given that we currently produce only about 1K Javelins per year, that's nearly 9 years' worth of production. Other weapons that are now classified as “limited” include Stinger missiles, MLRS rockets, and the M-777 howitzer.

We’re not the only country running low on weapons.

The secretary general of NATO, Jens Stoltenberg, recently called on NATO members to increase their defense budgets and to encourage weapons and ammunition manufacturers to step up production. With the exception of UK and Poland, European countries have been much slower than the United States to send arms to Ukraine--which some argue doesn’t just reflect slim stockpiles, but also fear of Russian escalation.

What does all of this mean for investors?

Last month, we pointed out that the evaporating stigma against defense stocks plus the increasing demand for defense production were pushing up investor demand for this sector. (See “Suddenly, Defense Contractors Are Cool.”)

The demand for more weapons has grown steadily, with the U.S. now committing to long-term military aid and the European Union just pledging to send more as well.

New production contracts are piling up, with the U.S. awarding Raytheon $624M to build Stingers, $311M to Lockheed Martin and Raytheon for Javelins, $824M to BAE Systems for armored personnel carriers, and millions more to other defense firms.

Three of the six largest defense contractors have seen double-digit share price growth so far this year, with BAE Systems (LSE: BA-.LN) up nearly +50%, Northrop Grumman (NOC) up +28%, and Lockheed Martin up +13%. (Meanwhile, SPY has declined nearly -25%.)

Only Boeing (BA) has bucked the trend and is down nearly -40%, but this can be attributed to problems with its civil aviation business.

One way to take advantage of the upside is to invest in defense ETFs.

Or, if you want to avoid going long in unrelated industries like aerospace or cybersecurity, you can focus on the individual large-cap tickers most affected by shortages, like LMT, RTX, and GD. One relatively small player is AeroVironment (AVAV), which makes the Switchblade "suicide" drones that are being used in Ukraine. It's up +22% YTD. (AVAV is held by several of Cathie Wood's ARK Invest ETFs.) 

Yet another tailwind in favor of defense is American efforts to arm Taiwan against a Chinese invasion. At the beginning of September, the Biden administration announced the sale of $1.1B in weapons to Taiwan--the largest arms sale to date.

The idea is to turn Taiwan into a "porcupine" attached to an on-site weapons cache, enabling the Taiwanese to defend themselves even after a long PRC naval blockade. Because the most heavy-duty weapons are going to Ukraine, officials have been encouraging Taiwan to purchase lighter types of arms.

And there may be more funding on the way: The Senate is currently considering the Taiwan Policy Act, which would provide another $4.5B in military aid over the next four years.

With demand so high, military officials are struggling to figure out how to accelerate production amid supply chain issues and labor shortages. According to CSIS senior adviser Mark Cancian, the conversion of civilian industry to wartime production took two to three years during World War II--and that was in an economy that was fully mobilized. If current conflicts worsen and the United States finds itself even further behind the curve, we will have to ramp up spending very rapidly.

How did we get into this fix? Well, think about the realities of peacetime production.

It's rational to stockpile only so much weaponry because, every few years, any particular weapons system gets updated with new and better technology. Even when technology stands still, moreover, equipment and ammo have a limited shelf life.

In short: Defense planners always knew that if a real conventional war broke out, we would be forced to mobilize. If many Americans may have assumed otherwise, it was because all the recent wars that have been waged by the United States have not been conventional wars.

They have been asymmetric wars against insurgents. (The "conventional" phase of the 2003 invasion of Iraq was over in a matter of days.) No recent conflict has involved the quantity of firepower we have witnessed in Ukraine, which has been engaged in conventional warfare along a 500-mile battle front for 7 months and counting.

How is the Ukrainian military going to manage until global production ramps up? Ironically, in recent weeks, the biggest supplier of heavy weapons to Ukraine has been Russia.

Its latest offensive in the eastern part of the country has been powered by howitzers, tanks, and rocket launchers left behind by retreating Russian soldiers. Ukraine has captured an estimated 421 Russian tanks--more than the 320 it has received from allies.

Not that Russia itself has much in its arsenal to spare. To replenish its also-depleted stocks, the country has been buying weapons from Iran and North Korea. At this rate, the outcome of the war might depend on which side runs out of weapons first.

*  *  *

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.