Companies that count on state and federal spending are trailing the Standard & Poor’s 500 Index for the first time in a year, a sign they’ll lose sales should Democrats give up control of Congress.
Lockheed Martin Corp., which gets almost all its revenue from defense projects, has fallen 5.9 percent since July as the S&P 500 rallied 16 percent, data compiled by Bloomberg show. Tenet Healthcare Corp. depends on the U.S. for about 33 percent of sales and is down 17 percent this year. A Goldman Sachs Group Inc. index of contractors getting at least 20 percent from governments started lagging behind the S&P 500 last quarter after beating it since September 2009.
Budget cuts spurred by Republican victories in the House or Senate may lead to more declines in the shares, which until August had matched the S&P 500’s gain since the start of the bull market, according to BlackRock Inc., Fifth Third Asset Management Inc. and Harris Private Bank. The party will hold a 20-seat majority in the House of Representatives after the Nov. 2 vote, according to FiveThirtyEight, a New York Times blog that forecasts elections by analyzing polls.
“There’s going to be a bridle put on U.S. government spending,” said Keith Wirtz, who oversees $18 billion as chief investment officer at Fifth Third in Cincinnati. “The market’s looking through its binoculars and suggesting less government spending in 2011 and 2012 will hurt the fundamentals of these companies.”
Trailing the Market
Stocks climbed last week, with the S&P 500 reaching a five-month high on Oct. 13, as investors bet the Federal Reserve will purchase Treasury bonds to stimulate the economy. The 1 percent gain to 1,176.19 brought the index’s 2010 return to 5.5 percent, according to data compiled by Bloomberg.
Goldman’s index of 54 government contractors gained 12 percent since July 2, when the S&P 500 slipped to its 2010 low of 1,022.58 before starting a 16 percent advance. The S&P 500 rose 0.7 percent to 1,184.71 at 4 p.m. today in New York.
The companies benefited after President Barack Obama began one of the biggest economic rescue programs in U.S. history within two months of taking office, making fiscal 2009’s federal deficit the largest ever. The fiscal 2010 budget gap of $1.29 trillion was about 8.9 percent of gross domestic product, data from the Treasury Department showed last week. It’s projected to widen to $1.42 trillion.
Spending to pay for wars in Iraq and Afghanistan boosted Lockheed and ITT Corp. Obama’s health-care overhaul signed in March would bring more insured customers to hospital-operator Tenet Healthcare, reducing losses from unpaid bills of patients who lack insurance.
House Republicans announced a governing agenda on Sept. 23 that would cut federal spending, extend expiring tax cuts and repeal the health-care law. FiveThirtyEight’s analysis shows Democrats will have a four-seat advantage in the Senate.
Spending by state and local governments rose 0.6 percent in the second quarter, after dropping 3.8 percent in the first three months of the year, the steepest decline since the recession began in December 2007, the Commerce Department said.
Companies with the biggest share of sales to the government “will likely be passed over as we tighten our belts,” said Jack Ablin, chief investment officer at Chicago-based Harris Private Bank, which oversees $55 billion.
Government contractors may bounce back as investors recognize that the threat of reductions is overblown, according to Scott Armiger, who helps manage about $5.6 billion at Christiana Bank & Trust in Greenville, Delaware.
“Cutting government spending is a two, three steps process,” he said. “Washington doesn’t change quickly. I don’t see it happening in just one midterm election. These companies will be OK for the next couple of years. It’s an overreaction to the downside and it could actually be a buying opportunity.”
Armiger said weakness in the Goldman Sachs measure may be caused by concern medical companies will be hurt by changes to the health-care law. The industry accounts for about half of the Goldman Sachs index. Defense and aerospace make up 20 percent.
A 25 percent reduction in government revenue would raise the median price-earnings ratio of companies in the Goldman Sachs index to 16.6 from 14.9, according to data compiled by Bloomberg using sales and income reported to the Securities and Exchange Commission. The S&P 500 trades for 15.6 times profit.
While potentially hurting these stocks, the loss of Democratic control of Congress may keep Treasury yields around record lows. President Bill Clinton was forced to drop spending initiatives after the 1994 congressional elections, helping send the rate on 10-year notes from 8.03 percent after the November 1994 election to 5.57 percent by the end of 1995, the data show.
Treasuries have returned 8.45 percent this year, according to data compiled by Bloomberg. The yield on the benchmark 2.625 percent note due in August 2020 rose 17 basis points last week.
Lockheed slipped 5.9 percent since the S&P 500’s low as Defense Secretary Robert Gates said he wanted to save as much as $100 billion through 2015. The world’s largest defense company, which gets 98 percent of sales from the government, agreed to build its fourth batch of F-35 Joint Strike Fighters last month, an order that may be valued at more than $5 billion.
Lockheed, based in Bethesda, Maryland, doesn’t speculate on national spending, according to Jeffery Adams, a spokesman for the company.
“We have undertaken a series of actions that are consistent with the new reality of a marketplace in which our customers are pursuing new productivity and savings goals in the face of escalating demands and increasing constraints on resources,” Adams wrote in an e-mailed note.
ITT Corp., which gets 58 percent of its revenue from its defense segment, has trailed the S&P 500 by about 9 percentage points since July 2. The value of ITT’s uncompleted contracts fell 21 percent in the second quarter to $4.1 billion after order deferrals.
David Albritton, spokesman for White Plains, New York-based ITT, didn’t immediately return calls and e-mails for comment.
“ITT and Lockheed are both in the defense industry, a category that probably enjoyed its best period in the last decade because of Iraq and Afghanistan,” Wirtz from Fifth Third said. “For those that are looking at the next five years, there’s a basis for why you want to avoid those stocks.”
Fifth Third sold 11,512 shares of ITT in the second quarter, reducing its holdings to about 50,000, according to data compiled by Bloomberg. It kept its position in Lockheed almost unchanged at about 56,000 shares.
‘Going to Be Tight’
Raytheon Co. in Waltham, Massachusetts, the world’s largest missile maker, has declined 4.4 percent since July 2. Wilsonville, Oregon-based Flir Systems Inc., which makes night-vision cameras for the U.S., has dropped 12 percent.
“It’s going to be tight for companies in defense,” said John Carey, a Boston-based money manager at Pioneer Investments, which oversees about $250 billion. “It’s one area where we’re going to have to pay a lot of attention with the winding down of the war in Iraq and depending on what happens in Afghanistan.”
Tenet, the third-largest publicly traded U.S. hospital chain, rallied 9 percent on March 22 after the House approved Obama’s health-care reform bill, which will extend benefits to 32 million uninsured Americans in 2014. The Republican agenda calls for a repeal of the bill.
“We saw health-care reform as a net positive for us over the long-haul,” said Rick Black, a spokesman for Dallas-based Tenet. “The more people that are covered will be beneficial to the whole system, as well as to hospitals like us.”
While rising 7.7 percent since July, Tenet shares have trailed the S&P 500 as speculation grew that Republicans will win control of House. Black declined to comment on the revenue impact of the Republican agenda.
In August, Mitch McConnell of Kentucky, the Republican leader in the Senate, opposed a proposal to add $16 billion to the federal budget to help states pay for the Medicaid health-care system for the poor. Some states already counted on the money when they drew up their budgets, and dropping the funding would add to nationwide shortfalls projected at $84 billion, according to data from the National Conference of State Legislatures.
House Republicans have pledged to cut $100 billion from the federal budget next year, which may include health research, Medicaid and Medicare for low-income seniors.
“The midterm election can be a significant force on companies that rely on government expenditures,” said Eric Teal, chief investment officer at First Citizens Bancshares Inc. in Raleigh, North Carolina, which manages $4.5 billion. “We’ve been paring back exposure to government spending a bit, too.”
Bob Doll, who helps oversee $3.4 trillion as vice chairman of BlackRock, said prospects for Republican victories and austerity among Democrats are weighing on the stocks and may lead to more declines before the year is over.
“Do we have fewer defense stocks in our portfolio than we had a couple years ago? The answer to that question is yes,” said Doll, who is based in Plainsboro, New Jersey. “The budget and the deficits are coming more under scrutiny, and as a result we’ve got to pay more attention.”