Edison Investment Research

Trumping Clinton on defence spending

A look at the potential impact of Donald Trump as President on US defence spending

“I’m gonna build a military that’s gonna be much stronger than it is right now. It’s gonna be so strong, nobody’s gonna mess with us. But you know what? We can do it for a lot less.” (Donald Trump)

Donald Trump is somewhat of an enigma when it comes to his military strategy. On the one hand he seems to have the US defence primes in his crosshairs. He frequently criticises politicians and defence contractors for colluding to build costly and unnecessary weapons systems, and he is determined to reduce the procurement budget. On the other hand he has spoken of wanting to increase troop numbers, buy new equipment and bolster the US military presence around the globe, particularly in the Middle East and China.

Putting aside my big picture concerns about the potential for President Trump to take office next year, to my mind the impending US presidential election looks to be a positive thing for the defence industry, no matter who wins. While many Democrats would like to see a lower defence budget, Clinton is likely to maintain the current budget trajectory as outlined by Obama – a status quo that the industry is able to manage. The Republicans are generally more pro defence spending and Trump seems to have big ambitions on the global stage. While he seems to want to try and spend less, he is unlikely to meet his strategic aims with a shrinking defence budget.

Trump’s controversial attitude to foreign policy makes the deployment of US troops look more likely than under the current, more pacifist Democratic regime. He is strongly against the Iran deal made last year and his criticism of Chinese trade deals and encouragement of Japan gaining nuclear weapons capabilities increases the chance of a conflict in Asia. His determination to build a border wall with Mexico will surely require increased military involvement.

The inefficiencies of Pentagon procurement processes are widely acknowledged, and so his determination to improve the system is to be applauded. While it might put uncomfortable pressure on the defence industry in the short term, making the system more commercial, competitive and transparent should be a good thing in the long term. If such improvements are made against the backdrop of a larger and more active US military, then it is hard to see how the US defence spending can decrease.

By nearly every metric of size – number of brigades, aircraft, ships, submarine battalions and end-strength – the US military in 2017 is smaller than when the build-up in the Middle East began in the early 2000s. Yet the budget is more than 50% larger (in real terms) than before 9/11 (as per the chart below from the Centre for Strategic and International Studies). The military and the US government assert that the capabilities of the force are improving. This is a hard claim to test, although logically the more technology-centred warfare makes spending on equipment rather than people seem logical. People cost money though, in training, housing and equipping. Therefore any increase in troop numbers by Trump will see a commensurate increase in spending.

DoD Budget authority and active strength troop numbers, FY1948 – 2017 (CSIS)

There are two major defence budget challenges that await the new President, irrespective of who it is:

1. The Budgetary Control Act (BCA) caps still remain in place for their original level FY18-21. The defence budget submitted this year for the next five years requests $113bn of funding, which is above the budget caps. The new administration must either broker a deal to remove the caps, or devise a defence strategy that can work within the caps.

2. The use of the Overseas Contingency Operations (OCO) budget to fund activities that should be in the base budget is coming under increasing scrutiny. Roughly half ($30bn) of the FY17 OCO budget is funding activities that were previously in the base budget. Many in Washington believe there should be no OCO budget when the US is not at war but currently the DoD is relying on it.

In conclusion, a victory for Trump is likely to be a small positive for the defence industry as the US defence budget should increase. The new President, whether Trump or Clinton, will only have a short period of time in which to influence the FY18 budget request because the budget development process takes more than a year, so is already well underway. However, they should have four months to insert any major strategy changes or alterations to high-profile equipment programmes, which will give us a flavour of the operating environment for the defence industry over the next four years.
Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.