A Major Character in the American Reindustrialization Story
National defense is a key backdrop of America’s need to reindustrialize. The GMO Domestic Resilience ETF (DRES) invests in companies we believe will benefit from American reindustrialization.
For much of the past several decades, the United States could be safely labeled the world’s sole superpower, with military might unrivaled across the globe. While such power did not always achieve unblemished results, as prolonged stays in Iraq and Afghanistan demonstrated, the United States’ global military reach was without rival.
In recent years, that dynamic has begun to shift, with China rising as a legitimate challenger. Twenty years ago, China’s annual military spending was a small fraction of the United States’. By most estimates, China spent less than one dollar on defense for every five dollars spent by the United States. Today, that percentage has nearly doubled, with current estimates suggesting that China’s annual defense spending is approximately 40% of U.S. levels.
The fact that China’s rise as an industrial power has coincided with its military advancements is not surprising. Since the Industrial Revolution in the late 1700s through early 1800s, sustained military power has depended less on battlefield tactics and more on a nation’s ability to mobilize industry, technology, capital, and logistics at scale.
As author Arthur Herman detailed in his book Freedom’s Forge, the United States achieved victory in World War II by combining private-sector industrial strength with coordination from the government. A country’s capacity to build and innovate at scale is closely linked with its ability to defend itself and its allies. Put simply, a country that can’t make things can’t defend itself.
Against this backdrop, the companies in the U.S. defense sector represent a dedicated area of focus for the Domestic Resilience portfolio. Our current defense holdings include several of the leading “prime” defense contractors: Northrop Grumman, Lockheed Martin, L3Harris Technologies, and Huntington Ingalls. Primes play a critical role in translating the requirements and funding provided by the U.S. military for national defense into the complex, scalable systems that drive the U.S. military’s power.
The government and companies working together to deliver U.S. national defense form a relationship that functions more like a partnership than a simple exchange between buyer and seller. As a result, defense companies tend to be steadier, longer-term focused businesses. While a stable relationship has periodic risks, including the potential to over-promise and under-deliver on military contracts, the defense sector has been home to a number of companies with successful long-term investor returns earned by successfully navigating government partnership.
Long-term success for companies in the defense sector is determined by two primary factors: company-specific excellence at developing and maintaining the products and systems the U.S. military requires, and overall levels of national defense spending. On the latter point, we think the current environment suggests cause for optimism.
Following strong growth in the post-9/11 ramp-up for combat in the Middle East, the 2010s were a tough decade for U.S. defense spending, which peaked at ~$750 billion in 2011 and didn’t return to those levels until 2020. While defense primes were able to generate decent investor returns during this period, stagnant defense spending was certainly a headwind.
However, with Russia’s invasion of Ukraine in 2022, an acceleration of activity in the Middle East following Hamas’s attack on Israel in 2023, and China’s continued acceleration of defense spending and capability, we’ve started to see movement in the U.S. defense budget, with 2026 spending likely to approach $1 trillion. This domestic spending growth pairs with a general acceleration in global defense spending, including by Western allies likely to spend a portion of their budget with U.S. primes.
In short, while defense spending is subject to annual ups and downs, we think an increasingly multipolar world with increased capacity for regional conflict supports general growth in defense spending that likely serves as a tailwind to U.S. defense companies.
Cutting Edge and Classified
Domestic Resilience’s top Defense holding, Northrop Grumman, is an excellent example of the industry’s close ties with American resilience. The company’s air and space systems include everything from drones and the company’s B-21 stealth bomber to satellites and the Sentinel intercontinental ballistic missile system.
As these products suggest, Northrop plays a critical role in maintaining the U.S.’s nuclear triad, a three-pronged military structure designed for nuclear deterrence. The triad is comprised of land-based missiles, submarine-based missiles, and strategic bombers, with Northrop playing a key role in land-based missiles and strategic bombers. Nuclear deterrence has been a critical portion of national defense since the end of World War II, and that seems unlikely to change any time soon, given that three other countries possess a nuclear triad: Russia, China, and India.
Northrop’s strong relationship with the U.S. military is also evidenced by the fact that approximately one-third of its revenues are from classified sources, underscoring its leading role in developing next-generation technology to defend America. Northrop has generated solid fundamental returns over the last decade in an era of muted U.S. defense budget growth, and we believe the company is well-positioned for a period of rising defense budgets.
Two If By Sea
The U.S. naval shipbuilding industry has struggled for several decades, bogged down by bureaucracy and an uncertain mission in a relatively peaceful world. China’s naval growth has finally drawn attention to the U.S.’s decline in this area, leading to considerable political and industrial effort focused on revitalizing and rebuilding the U.S. shipbuilding industry.
Recent defense appropriations for Naval shipbuilding have been trending higher, coming in the form of capital investments and wage increases to address a recent challenge within the domestic shipbuilding industry in attracting talented workers. Domestic Resilience holding Huntington Ingalls is the US’s leading pure-play naval shipbuilder and a likely beneficiary of this increased attention. The company’s recent partnerships with Western ally firms like South Korea’s Hyundai Heavy Industries to manufacture ships in America underscore a renewed commitment and focus.
In summary, the defense sector represents a critical link between a country’s industrial resilience and its national resilience. In an increasingly multipolar world where national self-sufficiency is more important than ever, we believe investments in the U.S. defense sector offer the potential for attractive returns.
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The GMO Domestic Resilience ETF (NYSE: DRES) is an actively managed fund designed to provide focused exposure to American manufacturing and the structural forces reshaping the U.S. economy through a disciplined, bottom-up investment approach.
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