Aerospace ETFs Try To Take Flight

Industrial stocks struggled last year as the sixth-largest sector weight in the S&P 500 was confounded by, slumping oil prices, the rising dollar and slack demand for some transportation services, among other factors.

The Industrial Select Sector SPDR (NYSE:XLI), the largest industrial sector exchange traded fund, is off more than nine percent over the past year. Last year, XLI and rival industrial ETFs were dragged lower last year by several of its marquee components. Caterpillar Inc. (NYSE: CAT), 3M Co (NYSE: MMM) and United Technologies Corporation (NYSE: UTX).

However, there are pockets of strength within the industrial sector and a lot of that potential strenght comes courtesy of defense stocks, including those held by the PowerShares Aerospace & Defense Portfolio (NYSE:PPA).

Recent acts of terror around the world and the ongoing fight against the Islamic State prompted an increase in defense spending in 2015, the first in four years.

These headlines indicate a shift from a four-year trend of declining defense orders, which appears to be bottoming even before newly expanded budgets can be deployed and reflected in government data. The US Commerce Departments November durable goods report showed a 44% jump in defense orders from October.Defense orders are highly volatile, but the six-month average is starting to climb after an extended period of weakness, said PowerShares in a recent note.

Given the always partisan environment on Capitol Hill, some investors are apt to believe that the performance of defense stocks and ETFs is intimately correlated to which party occupies the White House. While defense spending fell for several years leading up to 2015, it is worth noting that from 2009, the year President Obama took office, through 2015, PPA has outperformed traditional, diversified industrial ETFs in all but two years.

The $296.5 million PPA follows the SPADE Defense Index, which is designed to identify a group of companies involved in the development, manufacturing, operations and support of US defense, homeland security and aerospace operations, according to PowerShares.

PPA's top holdings include Dow components United Technologies and Boeing Co. (NYSE:BA) as well as Lockheed Martin Corp. (NYSE:LMT) and General Dynamics Corp. (NYSE:GD). The ETF's top 10 holdings combine for about 53 percent of its weight.

Valuations for defense and aerospace firms are also compelling. As of Dec. 23, the S&P 500 Aerospace and Defense Industry Index was trading at an 8.0% discount price-earnings (P/E) ratio to the S&P 500 Index. Relative valuations were richer in the mid 1990s and mid-2000s, but have come down since early 2014, adds PowerShares.

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