3 Defense ETFs to Play Defensive Amid Trade Uncertainty

When nervous, investors flock to so-called consumer staples, real estate and utilities. These three sectors have indeed been some of the best performing in the past 30 days, even if they remain below recent peaks in a current climate of unprecedented escalation of trade tensions between the world’s two economically dominant powers, the US and China.

The aerospace and defence sector tends not to be the first place that comes to mind as the ultimate ‘hideout’ sector when markets get jittery but, as an industry that’s only partially exposed to the global economy, it benefits from being at least a partial black hole for any macro-related volatility. Revenues are much more reliant on budgeted government expenditures and an ever-increasing number – and location – of potential hotspots. In March, the US president Donald Trump proposed $750 billion for national defence in 2020 federal budget, a $34 billion, or about 5 per cent, increase over what Congress enacted for the current fiscal year 2019.

Looking at multiples, the aerospace and defence part of the S P 500 trades at about 14.9 times measured on estimated 2020 earnings, a slight discount to the 15.6 multiple on the S P 500 overall.

We remain bullish on defence and we think it’s a good place to be,’ wrote Morgan Stanley analyst Rajeev Lalwani in a recent research report. ‘Increased near–term sales visibility out to the mid-2020s from a two-year budget deal… plays well with valuation against uncertainty,’ Lalwani added, according to Barron’s.

Traders who want to position for a more ‘risk-off’ environment as the ongoing trade negotiations between Washington and Beijing continue to ratchet up in an increasingly ugly trade war that has the potential to derail global growth should explore these three aerospace and defence exchange-traded funds (ETFs). They might be able to provide some defence amid the chaos.

iShares U.S. Aerospace & Defense ETF (ITA)

With a massive $5.13 billion asset base, the iShares U.S. Aerospace Defence ETF (ITA) seeks to provide similar investment returns, net of expense, to the Dow Jones U.S. Select Aerospace Defence Index – a benchmark comprised of companies that manufacture, assemble and distribute airplane and defence equipment. The ETF’s basket of 35 stocks has The Boeing Company (BA) and United Technologies Corporation (UTX) as top holdings, each with nearly 40 per cent cumulative weighting.

More than $30 million of dollar volume liquidity most days, coupled with a narrow 0.03 per cent spread, keep trading costs ultra-low. The fund’s management fee is on the expensive side for the segment, but remains competitive. The fund’s offering includes a 1.07 per cent dividend yield and was up 22.97 per cent YTD (as of Aug. 7, 2019) outperforming the S P 500 Index by 8 per cent over the same period.

ITAS (ITA shares) enjoyed a 32% pop from their December 2018 low to their February high before taking it on the chin as it retested the 200-day simple moving average (SMA) in March. Since then, the ETF has traded in orderly ascending fashion. The most recent and quick excursion under the band followed by a reversal and return to congestion played out this past December. Price tried to penetrate the channel’s lower band yesterday but was met with serious buying interest at that level. Sellers need to consider taking profits on any longs near the channel’s upper band and put a stop below yesterday’s low at $208.07.

SPDR S&P Aerospace & Defense ETF (XAR)

SPDR S&P Aerospace & Defense ETF (XAR) is designed to broadly represent the price and yield performance of the S&P Aerospace & Defense Select Industry Index. The underlying index comprises companies in the U.S. aerospace and defence sector, as defined by The Global Industry Classification Standard (GICS) – a trademarked classification system for equities jointly sponsored by Morgan Stanley Capital International (MSCI) and Standard 8 Poor’s.

The ETF, established in 2011, lags the benchmark in being weighted 40/40/20 in large-, mid-, and small-cap stocks, respectively. XAR holds a portfolio of 30 names; the top 10 holdings consume 43.30% of the portfolio. Nearly 125,000 shares trade hands per day, providing traders substantial liquidity. It manages $1.62 billion in assets under management (AUM). The management fee is an incredibly competitive 0.35%, and the fund is up 31.24% so far this year.

The XAR has been rising steadily since the 50-day simple moving average crosses above the 200-day SMA signal in mid-march to give a ‘golden cross’ buy signal. The price fell below key near-term support in the $100 level on Monday, 5 August, but quickly reversed direction to close higher for the session. It’s this rejection below the $100 zone that could fuel further buying pressure ahead of the week coming with swing traders eyeing an opportunity to buy on the dip. Those trading with an open position may wish to place a take-profit at $110, a level that could meet resistance from a trendline that spans above the recent peaks. Net of the rally, traders could look to protecting holdings by using a stop placed beneath yesterday’s candle low at $101.31.

Direxion Daily Aerospace & Defense Bull 3X Shares (DFEN)

DFEN was created on 15 March 2017, and it is designed to offer three-fold (3X) the daily return of the Dow Jones U.S. Select Aerospace Ė Defence Index (make sure you don’t get confused by its inverted counterpart, DFDS). Let us take an example of the benchmark index that, on a particular day, rose by 1 per cent.

The ETF wants to aim for an identical return of 1 per cent but multiplied three-fold, hence 3 per cent. In reality – as a result of compounding and the daily rebalancing requirement – the fund’s return will generally not exactly match the advertised 3X leverage, and that is something to keep in mind. It should not be a tool for the buy-and-hold investor whose goal is long-term capital appreciation. We speak of expert trading hands.

The geared exposure is framed as a one-way bet on the leading players of the aerospace and defence industry, and makes use of giant ticker symbols, such as Boeing, United Technologies, and Lockheed Martin Corporation (LMT). A bear strategic rationale would be to use limit orders to mitigate the slightly steep average spread of 0.17 per cent, in addition to the middling volume. The current net assets size of DFEN stands at $56.33 million. The fund’s expense ratio comes in at 0.98 per cent. Its year-to-date (YTD) return, as of 7 August 2019, stands at 71.15 per cent.

Since DFEN tacks the same underlying index (ITA), the charts look very similar. A pullback to the lower trendline of the ascending channel/200-day SMA offers an attractive risk/reward buy trade. RSI remains below the 50 neutral mark, leaving plenty of room for the price to test higher prices before eventually consolidating. Buyers must use the October 2018 high of $64.16 as a retest for potential entry. A stop-loss order placed just below yesterday’s low at $48.93 gives the trade a 1:7 risk/reward ratio ($13.34 profit target / $1.90 stop loss) should ITA fill today near $50.82.