Over the last several months, readers of Small Cap Strategy Report and Small Cap Insider know that I have been very bullish on infrastructure investing, defense, and healthcare. I even think that a few deeply discounted stocks in housing are pretty attractive at these levels – not all, but a couple. Our best idea in infrastructure is up 22% since we recommended it, and I think there is still time to get in on some of our other interesting plays.

Defense, in particular, is still a very strong investment theme and it’s not going to go away anytime soon.

Democrats are clearly trying to distance themselves from the war in Iraq. Some are even calling for greatly curtailed spending on the campaign, which will likely never find much support as long as American soldiers are under fire on foreign soil.

Even if America leaves Iraq, equipping it with only the guns and equipment that local forces claim they need desperately, the fact is that the United States is and will be on a war footing for years to come. Securing the home front – whether through offensive or defensive means – will continue and money will flow to defense contractors at a healthy rate. Anyone who thinks that this sector will not be a major ongoing magnet for investment capital believes in a peacetime we’re probably not going to see for a while…

In fact, just last Tuesday, Northrop Grumman tested a laser missile defense system on a FedEx plane flying out of LAX. The Department of Homeland Security has funded a lot of the development in this technology that will ultimately trickle down to commercial jets. Initial costs guesses are $1 million per plane for a defense system, with more than $350 per flight in maintenance costs. And that expense has to be spread over the nearly 7,000 planes in the current U.S. fleet…

And that’s why we’ve been so bullish on defense, even in light of the massive run up in these stocks. Spending will continue and we still think there are some defense stocks out there that do not fully reflect the business that will be coming their way.

For The Sleuth this week, I want to bring to your attention a great way to dip your toe into the defense stocks arena.

It’s not a targeted approach like our individual defense stock recommendations.

It’s an exchange traded fund (or ETF), and typically I wouldn’t feel comfortable even mentioning such a watered-down approach to investing in a theme in which I feel so strongly about.

But the reason I mention this ETF is that I have done due diligence on almost all of the stocks within it, and many are still attractively priced. But first, let me tell you about the fund…

The PowerShares Aerospace & Defense Portfolio (PPA) tries to mirror an equity index called the SPADE Defense Index. It’s extremely focused and not diversified much at all outside of defense and aerospace.

Typically, PPA invests a minimum of 80% of its total assets in stocks of aerospace and defense companies, and usually 90% or more in those that are in the SPADE Index.

The SPADE is comprised of about 50 U.S. companies, with a lot of large- and mid-caps as well as a fair representation of small caps.  Here is a sample of the stocks included, and remember, the S&P 500’s earnings multiple right now is 21.1x, so many of these assets are trading at a discount to the broader market.

I encourage you to contact PowerShares directly or your broker for more information on this fund. In the meantime, we’re actually doing our homework on a new defense stock that company insiders have been quietly plowing their own money back into… It might just be one of our new recommendations for Small Cap Insider.

Until next time,
Craig
January 18, 2007

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