Getting Defensive

1+

It is a big week for Aerospace and Defense. After last week, in which United Technologies registered pretty substantial earnings and top-line beats, the week of January 28th will see reports from Boeing (BA), Lockheed Martin (LMT), Northrop Grumman (NOC), General Dynamics (GD) and Raytheon (RTN). Here we explore the current narratives for the industry and its key members.

Our first stop will be the narrative map over the last quarter for the industry more broadly. A few observations:

  • There are some industries in which people writing about the businesses and people writing about the stocks tend to use very different language. This is one. When certain business topics are linked to the stocks / financial language, we think that is worth noticing.
  • The temporarily suspended US government shutdown is not well-integrated into the stock price narratives of the industry more broadly.
  • The biggest surprise we noted was the apparent lack of attention to trade and tariff issues faced by these companies in comparison to other sectors. What you will see from the stock-specific network maps, however, is that these topics do not coalesce into their own cluster because they are so ubiquitous in almost every topic at present.
  • Instead, attention at the market level (bottom left) appears to be much more focused on and connected to discussions of commercial air travel, orders, competition and – somewhat surprisingly – the impact of Brexit.
Source: Quid, Epsilon Theory

While the broad industry interests us, we also wanted to explore the two largest aerospace and defense players (other than the multi-industry United Technologies, which has already reported): Boeing and Lockheed Martin.

Boeing

Boeing has a low-attention narrative structure – even more so than the broader industry – by which we mean that people who are writing articles or research about the stock are using language that bears very little similarity to comparable discussions of its business, products, technologies and people. It is our belief and has been our observation that these narrative structures are more susceptible to new event information (i.e. we believe that they reflect asymmetric discounting of fundamental information). Low-attention in our taxonomy does not convey information about sentiment. In this case, sentiment for Boeing is mixed, which reinforces our belief the company is more susceptible than usual to event-related surprise and volatility (and that we would be less inclined toward most trend-following strategies relating to the stock).

As you will observe in the chart below, the data indicate three largely separate types of language being used in discussions about Boeing in the last quarter: (1) Market-focused article language, (2) Commercial Aircraft-focused article language and (3) Defense-focused article language. To be clear, this does not necessarily mean that this is what the articles are about, but that they share language with other stories than tend to be about those topics more broadly. We have highlighted these “meta-clusters” in the oval-shaped areas. The separation of these topics from one another is much stronger than we typically observe. General observations we would make about Boeing’s narrative structure:

  • We see very little evidence of a strong central narrative.
  • While the meta-clusters are fairly loosely connected to market narratives about the stock, unlike the broader industry, this map shows how closely the China Trade War narrative is to the core of stories being written about a company like Boeing.
  • We were surprised to see the (relatively high) connectedness of air travel safety topics as well. To the extent investors believe that such concerns tend to be overstated, we think there would be some reason to believe that those concerns may be overdiscounted.
Source: Quid, Epsilon Theory

Lockheed Martin

The Lockheed Martin narrative map is still fairly disconnected, but less so than Boeing’s. We would consider it a map of moderate attention. Discussions of some – although not all – of Lockheed’s various projects and competition use very similar language to what is used in analysis of its stock and financial prospects, and demonstrate much greater interconnectivity. In general, relative to Boeing we think this makes the stock more resilient against event-related surprises (both positive and negative) from topics close to the center of the narrative and its explicitly market-related topics.

Our key observations about the narrative structure for Lockheed Martin:

  • Trump’s foreign policy is deeply embedded into the narrative about Lockheed Martin. This is not a novel observation about Lockheed Martin or any company with such a heavy defense focus, but the narrative confirms that intuition: when people talk about Trump’s influence on geopolitical risk, they use a lot of the same language they use to talk about Lockheed’s opportunity set.
  • In our judgment, the projects most closely connected to the stock narrative are, in this order:
    • F-35      
    • Aerial refueling (MRTT)
    • Long-range anti-ship missile (LRASM)
    • Hypersonic missile and drone contracts (most articles general, less project-focused)
    • Littoral combat ship (LCS)
  • As per usual, F-35 sentiment is almost uniformly negative, but we do note a significant number of articles with Fiat News language that focus on new technology packages, impressive air-to-ground strike tests, etc. Not explicit propaganda, but it is clear to us that there is missionary work about the F-35 taking place to shift the sentiment in a positive direction. Over the past three years, there were 246 stories in our universe of high-circulation sources calling the F-35 program a failure, 144 calling it a disaster and 143 calling it a mistake. Over the last quarter, the frequency of those words has been cut in half, except for ‘disaster’, which made zero appearances. Whether we agreed with those observations or not, we would be very mindful of how they are influencing real narratives, as this has been a significant negative part of the LMT narrative for a very long time.
  • Saudi weapon sales and the Kashoggi event are STILL part of the entangled “Trump Foreign Policy” narrative. This hasn’t gone away as an issue for Lockheed Martin.
  • Space, rocketry and satellites are very disconnected from the core Lockheed Martin narrative.
  • As we noted in our banking note from two weeks ago, gender remains a major topic across industries. With a woman as CEO, this is a very intensely connected part of the Lockheed Martin narrative and makes its way into topics of surprising breadth.
Source: Quid, Epsilon Theory

PDF Download: Getting Defensive

1+

Disclosures

This commentary is being provided to you as general information only and should not be taken as investment advice. The opinions expressed in these materials represent the personal views of the author(s). It is not investment research or a research recommendation, as it does not constitute substantive research or analysis. Any action that you take as a result of information contained in this document is ultimately your responsibility. Epsilon Theory will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. Consult your investment advisor before making any investment decisions. It must be noted, that no one can accurately predict the future of the market with certainty or guarantee future investment performance. Past performance is not a guarantee of future results.

Statements in this communication are forward-looking statements.

The forward-looking statements and other views expressed herein are as of the date of this publication. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Epsilon Theory disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities.

This commentary has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Epsilon Theory recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.