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Defense sector grows with the global economy

Ally Schmidt

Surviving the slump: Key indicators of the defense industry (Part 2 of 8)

(Continued from Part 1)

Global economic growth

The past 20 years has seen a dramatic shift in global economic growth that has, in its turn, affected global defense spending. The sub-prime crisis of 2008 stalled growth in the US and elsewhere. And meanwhile, emerging economies grew faster, led by reforms and urbanization. Between 2009 and 2012, China recorded growth of 30% and India, 22% in real terms. In the same period, the United States grew by 7% and Germany grew by 7.9%.

Why economic growth is important

Global threats to a nation in large part determine how much will be invested in military strength expansion. But to invest money, a country first needs to generate money, and that is determined by its economic growth. The faster the global economy grows, the higher the defense spending. You can see this quite clearly in the above chart.

Following the global crisis in 2008, there was a marked shift in defense spending growth from developed countries to emerging ones.

Research and development

Investments in research and development (or R&D) also follow economic growth and so here, too, we see a similar upward trend among emerging countries in the global economy. Since 1991, the developing economies have bumped up R&D investment. China alone has increased R&D investment from a mere 1% of its GDP (gross domestic product) in 1991 to 9% more recently.

Recently, however, major defense companies from more developed economies such as Lockheed Martin Corporation (LMT), L-3 Communications Holdings, Inc. (LLL), TransDigm Group Incorporated (TDG), and B/E Aerospace Inc. (BEAV), have reduced their R&D spends. For more on this topic, read Why LMT is reducing its spending on research and development.

In the same period, R&D investments in Japan and Europe combined fell by 11%.

The R&D gap between the developed and developing world is narrowing. As a result, it’s expected that the quality of defense equipment coming out of the emerging parts of the global economy will improve.

Having said that, overall economic growth has slowed. Consequently, global defense spending has slowed. We’ll see how defense spending is affecting the defense sector in the next part of this series.

For broader exposure to defense stocks, investors might consider the SPDR S&P Dividend ETF (SDY).

Continue to Part 3

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