AMA

It is a challenge to do an “Ask Me Anything” when you are not that interesting. And my schedule is pretty chaotic these days. (I am trying to take in a lot of high school soccer and baseball this spring.) But for some reason, people do have questions.

My solution was to solicit questions on Twitter and elsewhere, and to tackle a few of them now. I got a lot of really good ones! I’m not going to get to all of them now (sorry if you asked and it wasn’t answered), but I do plan to do this again.

Have a question and didn’t get it in? Have a question about the answer to one of these questions? Reach out on Twitter or via a DM, or email me at lou.whiteman (at) live dot com.

And here goes nothing…

All my snarky talk about those who ride the wave. But what happens when the wave finds you?

I’ve probably heard someone say some version of “Actually, you know defense companies were the ORIGINAL tech stars back in the 1960s” a half dozen times in the last month or so. And I’ll confess every time I hear it, I cringe. (I don’t cringe because I disagree. It is a factually correct statement. I cringe because it isn’t much of a reason to buy a stock in 2023.)

The real answer, though, is: This is to be expected. Quick story: I was focused on venture capital in the late 1990s, back when the entire world was being consumed by dot-coms and every city in the western world wanted to have a Silicon Something. It was Silicon Alley in New York. In Washington, DC, where I was, and where nothing is ever creative, the buzzy thing to do was to call it “The Silicon Valley of the East.” Just rolls off the tongue, huh?

So anyway, I would go to all of these events along the Dulles Connector in Northern Virginia and meet all of the AOL millionaires turned venture capitalists and the young companies they were nurturing. The defense companies were there too, but they were the uninvited not cool kids at the party. Government revenue was so yesterday.

Fast forward two years or so, after the crash. These same events were much less crowded. And those who did make it, the people who were the cool kids two years prior who were still in the room, they all had pivoted to government work. After all, the government can pay its bills. A bunch of the other hip kids from before had been acquired by defense companies for pennies on the dollar.

Some version of that happens every time there is a downturn. The government is slower growth, perhaps less adventurous, but they have a 200-plus year history of paying invoices and the ability to print money to pay them. When times are good, we tend to ignore the pluses of defense and government services. We chase waves, trying for overnight 10x stocks instead of overtime multibaggers. These days, the predictability of a government order book and a 2% to 3% dividend yield looks pretty darn good.

This too shall pass. And eventually we’ll be back to the part of the business cycle where Palantir will be talking about the potential of its commercial business again. (Sorry, not sorry.) My only hope is those who are infatuated with defense stocks now leave those investments in place when the new up cycle comes and put new money to work chasing the dream. The best way to do defense investing is buy and hold as long as possible. Years from now the benefits of slow, steady compounding will serve you well.

We act as if the answer here is an either or, like a light switch is either on or off. The answer is far more complicated.

I've been on a lot of flights. By my estimation they have all had good landings. In that, none of them have ever crashed. But the actual quality of the landings has varied greatly. Ask a pilot and they will tell you that even they don’t know exactly how a landing will go. They have data that tells them the general conditions/what challenges they face, but when the moment comes, we are just one wind gust away from quickly needing to make an adjustment.

I think the economy is similar. And just as the pilot can’t predict exactly how the landing will go, not even the Fed knows exactly what happens next in terms of Big Macro. Like the pilot checking his/her dashboard, consulting tools, and relying on past experience, the Fed and all Fed watchers are making their best estimates based on the current data. But that doesn’t mean that they can forecast the future.

To keep the pilot analogy going, I’d be surprised if we have a picture-perfect smooth landing. But I also think it is highly unlikely that we crash. It all comes down to how much turbulence we'll actually face in the moment, how much of a gust we get, and none of us will know that until it is in the past.

That’s why we keep our seatbelts fastened.

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I love this question.

A fact about me: I was born in London. Or, just outside of London actually in a suburb called Northwood. There are a bunch of little clubs in that part of the world but right across in Hertfordshire the biggest club around is Watford FC.

It happened to be the beginning of a Golden Age of sorts for Watford. In 1976 Sir Elton John became chairman and director of his boyhood club, and appointed Graham Taylor as manager. Taylor is the most important manager in the club’s history, and a legend of the game. Elton’s money and Taylor’s eye for talent saw Watford jump three divisions in short order, landing in the First Division (this was before the Premier League).

We left for Dublin, and then eventually the states, before it all played out, but the fairytale engaged my father, and kept him interested after we had gone. They weren’t anything near our hometown any longer, but it just made sense for me to follow them.

This was before the age of major international television contracts, of course. When I was just out of college (mid-1990s) I was working near the White House in Washington, just down the block from an international newsstand at Farragut Square. At the time my only connection, my only way to “follow” Watford, was to pick up an old newspaper once a week and check the table or look for a one-off game summary. Nowadays, I can stream every game.

Technology is amazing. And there is no other club for me.

This is a complicated question. Questions, actually.

The simple answer to that first question is it is very important. New defense platforms don’t come along often, and the fighter platform is the biggest thing out there. The F-35 is going to be a trillion dollar-plus program for Lockheed Martin and its suppliers over its lifecycle (including maintenance and spare parts). The “Next Generation Air Dominance” (NGAD) sixth generation fighter is the next chance to get a piece of the pie, and will set up the winner well for billions in guaranteed revenue over time.

It is also important for R&D. Programs like this begin as a bakeoff, with multiple participants, and Lockheed, Northrop, and Boeing have already benefitted from being able to have their engineers push the envelope on the government dime. Whoever wins the final award will get billons more in research and experimentation funds that will become the foundation for their future effort to win whatever comes after NGAD.

A more nuanced answer would be it means more to Northrop than it does Lockheed, and more to Boeing than it does either. Lockheed has a multi-decade winning streak going with the F-22 and F-35. It also has a massive R&D pipeline in hypersonics and other future weapons, and I expect the Sikorsky unit will win the FARA attack helicopter bakeoff. Now granted, neither the F-22 nor the F-35 has sparkled post-competition, but Lockheed has greatly benefitted and has built a deep bench and a substantial knowledge base along the way.

Northrop has the B-21 Raider bomber win to fall back on. But you have to go back to the 1990s and the F-18 to find a Boeing attack win, and even that was a plane design that Boeing acquired through its deal for McDonnell Douglas. Boeing has faced a lot of reputational hits on both the commercial and defense side (the tanker deal, which by the way caused a few Boeing execs to go to jail, has been a disaster). Put simply, Boeing needs this more than anyone.

Your second question, asking if the winner would see significant upside for the stock, is much harder to answer. To some extent, yes! For all of the reasons listed above. This is the sexiest platform the Pentagon buys, at least the sexiest one that is above sea level. (No hate mail from the deck of the USS Gerald R. Ford, please. Carriers are massive and cool but not sexy and not the future.) But as we’ve seen with Lockheed, these programs also tend to be fraught with risk and unforeseen expenses, and the inevitability result in pushing the envelope is things will not work as planned.

I’m convinced that the Pentagon believes it went too far in allowing consolidation following the Cold War, and today’s industrial policy involves distributing work evenly enough to make sure everyone left is viable. So big picture, there are no losers. There are few programs that deliver like the fighters do in terms of revenue, and at least in the near-term there likely is a benefit to the winner. But for the most part I’d expect it to be business as usual for all regardless of who wins.

PS: I know others will disagree, but I still think it is Lockheed in the driver’s seat. We’ll see.

Confession: I invest in a lot of things I don’t really understand. I’d say that designation would apply to more than half of my portfolio.

A second confession: I am pretty full of myself. I don’t lack in self confidence. I do believe there are things I really do understand. And I believe I understand them more than most people.

That said, given the choice, I will happily make my brilliance subservient to things more reliable than brilliance. In this case, my feeling is:

Diversification > Brilliance

Even my brilliance.

Look, there are limits to diversification. I have five aerospace companies (six if you count AerCap, which you shouldn’t because it is finance) and a logistics company among my top 20 individual stock holdings. I’m not trying to replicate the S&P 500. But I have a portfolio of more than 80 stocks. I want to have a range of things in that portfolio. Including, for all the reasons I mentioned before, areas like semiconductors that I see great promise in even if I don’t fully understand them.

At least consciously, the biggest thing for me is I have greatly reduced the benefit of the doubt I am willing to give a stock. Not that giving a stock the benefit of the doubt was really my thing. But I am a firm believer that the amount of risk an investor is willing to take declines faster than rates increase. Or put another way, for every 1x increase in rates there is a 3x or 4x decrease in risk tolerance.

That has basically played out in valuation changes since the beginning of the rate increase campaign. Yes, rates are up dramatically. But they are not up in such a way that should (yet) lead to a panic. Yet valuations among the riskiest companies have fallen much more than the current economic environment would imply is justified.

I’m not much of a high-risk investor, but I do want a portion of my portfolio to be moonshots. And I am willing to take on added risk to try to find a big winner in that section of my portfolio. Generally speaking, I’m pretty picky about what companies make up that part of the portfolio even in the best of times. But my willingness to say, “what the heck, give it a go!” to suspend disbelief, so to speak, has decreased as rates have climbed.

The other thing isn’t really a change in process, but a change in where I am hunting. I’ve talked before about how I believe that the rate hikes have created temporary challenges for good businesses. For an investor who is trying to look past the wave, past the current sentiment, and hold for decades instead of quarters, it is a good time to be searching for opportunities.

Screw you.

(There are a lot of great questions I didn’t get to. I didn’t even get to my favorite question! A literature one! So more to come. And keep them coming in!)

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