President-elect Donald Trump's proposed Department of Government Efficiency (DOGE), led by Elon Musk and Vivek Ramaswamy, is raising questions about the future of U.S. defense contractors and government IT firms.
Could the defense budget flatten—or even fall? And who stands to gain in this new sector shake up?
DOGE Puts Defense Budget Under Pressure
Trump's plan to restructure federal agencies and reduce wasteful spending through DOGE is a bold move, and its potential ripple effects are hard to ignore—especially for defense and government IT companies.
With the Department of Defense (DoD) being one of the largest slices of federal spending, investors are understandably focused on what's next for defense stocks in a DOGE-driven world.
On one hand, Trump's campaign has consistently expressed support for strengthening the U.S. military.
On the other, it's hard to make sweeping government cuts without touching the $877 billion defense budget, which accounts for 13% of federal spending as of 2023.
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Defense Spending At All-Time Highs Spells Risks
Historically, defense spending runs in decades-long cycles. Investment in the sector experiences periods of growth followed by downturns, and we may be nearing the peak of the current cycle, according to Goldman Sachs analyst Noah Poponak.
“The defense budget is at an all-time high, which creates difficult comparisons and challenging base effects,” the analyst said in a note published Friday.
Key Risks For Defense Stocks
- Peak Spending: The defense budget is hovering at historical highs, making future growth difficult.
- Geopolitical Shifts: If major conflicts ease, defense spending could decline.
- Government Debt: U.S. debt-to-GDP ratios are near record levels, increasing pressure to curb federal spending.
Margins in the defense industry are already under pressure due to Pentagon efforts to shift risks onto contractors. Fixed pricing on long-term contracts, for example, has eroded unit economics.
At the same time, defense stocks – as tracked by the SPDR S&P Aerospace & Defense ETF XAR – are trading at valuations above historical averages, leaving them vulnerable to a "de-rating" if the budget flattens or falls.
“It is difficult to embark on any large government spending reduction effort without touching defense, and there are potentially enough inefficiencies within the defense budget to reduce its total level without necessarily reducing military readiness or capability,” Poponak said.
The investment bank maintains a cautious stance on the defense sector, issuing Sell ratings for Lockheed Martin Corp. LMT, Northrop Grumman Corp. NOC, L3Harris Technologies Inc. LHX, and Huntington Ingalls Industries Inc. HII.
Government IT: Winners In The Efficiency Game?
While defense hardware could take a hit, government IT firms might find themselves potentially on the winning side of DOGE.
The sector has been outperforming traditional defense industries in revenue growth, driven by a market share shift toward advanced technologies like artificial intelligence, data analytics, and cybersecurity.
Why IT Could Shine:
- Tech-Driven Efficiency: DOGE's focus on cutting waste could emphasize the adoption of technologies that streamline government operations.
- Advanced Capabilities: Firms offering cutting-edge solutions may be seen as key enablers of government efficiency.
- Resilient Demand: Even with DoD cuts, IT spending for Operations & Maintenance and national security could remain strong.
Goldman Sachs believes that companies like Booz Allen Hamilton Holding Corp. BAH and Leidos Holdings Inc. LDOS are well-positioned to benefit.
On the flip side, SAIC Inc. SAIC faces challenges due to slower growth and tougher competition, earning it a Sell rating from Goldman Sachs.
The bottom line is that Investors should prepare for a sector shakeup, as the creation of DOGE could mark a significant shift in federal spending priorities.
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