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As the fifth anniversary of 9/11 approaches, and with Britain's foiling of another airborne atrocity still fresh in their minds, the world's travelers are still on tenterhooks. Even so, they are traveling.
U.S. revenue passenger miles are running 3.3% ahead of their 2005 level this year, according to the U.S. Bureau of Transportation Statistics. That's good news for the air-travel sector's investors. Fidelity Select Air Transportation Fund (FSAIX) has advanced an annual average of 6.2% in the five years ended Aug. 18, more than two percentage points ahead of the market. This year it is racing away from the market with an advance of 7.8%.
As well as failing to destroy aviation, Islamic terrorists spurred huge defense spending. Fidelity Select Defense & Aerospace Fund (FSDAX), a big benefactor of that budget bulge, has mushroomed an average 15.8% a year in the past five years.
So those two funds would have been outstanding investments five years ago. But is buying the friendly skies (or the fierce ones) a good idea now?
Mutual-fund companies think so. In recent months, two new defense and aerospace portfolios have been created, both exchange-traded funds, to offer Fidelity its first competition in this market niche.
With a softer economy looming, investors need to find niches that can continue to grow. Defense, of which aviation is a major subsector, is one of these. I think these funds have legs.
Learning to love the bombs
Defense is something of a political football, but U.S. troops are on the ground overseas and serious money is being spent to support their mission. Raytheon (RTN, news, msgs), a maker of missile systems, intelligence technologies and aircraft, saw revenue surge 31% between 2002 and 2005, and income swing from a loss of $640 million to a profit of $871 million.Raytheon is one of the Top Five holdings of two of the four funds in this marketplace, and among the Top Ten of a third, PowerShares Aerospace & Defense (PPA). MSN Money's StockScouter system ranks the stock an 8 on a scale where 10 is perfect.
More from MSN Money
The portfolios of all four funds -- iShares Dow Jones US Aerospace & Defense (ITA) is the fourth -- are top heavy with stocks ranked 8 to 10, which are expected to significantly outperform the market in coming months, with less risk than other top-performing stocks. Raytheon's StockScouter page notes that the company's earnings are accelerating, that analysts have raised their estimates of future earnings and that shares are trading above their 50-day moving average, a sign of investor approval.
| Stock | StockScouter rating | Stock | StockScouter rating |
|---|---|---|---|
6 | 8 | ||
8 | 8 | ||
10 | 4 | ||
4 | 8 | ||
8 | 4 | ||
Average | 7.2 | Average | 6.4 |
6 | 8 | ||
4 | 6 | ||
8 | 4 | ||
8 | 7 | ||
8 | 8 | ||
Average | 6.8 | Average | 6.6 |
Note: MSN StockScouter rating system: 1 is worst (avoid) and 10 is best (significantly outperform). Sources: Funds, MSN Money
The average StockScouter ranking of the top-five positions of each fund clusters around 6.8, indicating they should outdistance the average stock in coming months. Each of the funds puts between 30% and 40% of its assets into its top-five names, so its overall performance is heavily reliant on those picks alone.
The StockScouter system, developed by my colleague Jon Markman, is sometimes in sync with Wall Street's consensus forecast for a company. The system rates General Dynamics (GD, news, msgs) as an 8, meaning it is expected to significantly outperform over the next six to 12 months. Not dissimilarly, Zachs Investment Research reports that eight stock analysts currently rate the stock a strong buy, one a moderate buy and seven a hold.
But StockScouter is sometimes contrary, because it takes into account factors other than just fundamentals, which are what most stock analysts focus on. StockScouter ranks Boeing (BA, news, msgs)a 4, which verges on a conventional ranking of sell. Zachs, whose ratings are published by MSN Money, reports that Wall Street's opinion is much higher: Nine analysts rate Boeing a strong buy, one a moderate buy, four a hold, one a moderate sell and three a strong sell.
StockScouter downgrades Boeing because its price-earnings multiple is relatively high for its group, making it vulnerable to a decline simply if its popularity fades. It also notes that one or more analysts recently have lowered their quarterly earnings estimates for the company, which is the sort of factor that can puncture a high-P/E stock's appeal.
A bet on airlines
Despite their many similarities, the funds investing in these stocks have significant differences. Fidelity's Air Transportation is unlike the other three in its strict focus on aviation. Three of its top positions are airlines -- Southwest Airlines (LUV, news, msgs), AMR (AMR, news, msgs), parent of American Airlines and UAL (UALAQ, news, msgs), parent of United Airlines -- in which the other three don't currently hold big stakes.The two Fidelity funds are actively managed by stock analysts with expertise in the areas in which they specialize. The two exchange-traded funds (ETFs) track indices: The iShares Dow Jones index follows the largest companies in the sector; the PowerShares index is customized to stress what PowerShares believes are the strongest stocks within the sector.
While the Fidelity funds have lengthy track records, both of the ETFs were launched in the past year and thus don't offer that kind of insight into how they might behave. At present, their holdings are similar both to each other and to Fidelity Defense, but that could change. If you are interested in them, read the prospectuses carefully; they are more unknown than known.
But the defense and aerospace theme has shown resilience, which the market itself has been notably without.
Middleton is the author of "The Bond King: Investment Secrets from PIMCO's Bill Gross," and the former mutual funds columnist of The New York Times. He works from home in Short Hills, N.J. At the time of publication Timothy Middleton didn't own any securities mentioned in this article.
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