Aerospace Is Ready to Fly

I've written about my positive outlook for pure-play defense stocks a couple of times over the past two weeks. But there's another closely related business that I'm also particularly keen on, and that's commercial aerospace.

While investors today are focused on how sharp the U.S. slowdown will be, other parts of the world are enjoying robust economic growth. Global GDP growth, in turn, typically generates a pickup in air traffic. Driven by fast-growing emerging markets, worldwide traffic growth is surging -- well above its long-term trend -- and shows no signs of abating.

As traffic rises and load factors, or the percentage of seats filled, are near 80%, airlines seek to boost revenue and profits by adding capacity, fertilizing a new increase in demand for commercial aircraft.

In previous cycles, most of this new demand came from North America and Europe. Even as recently as the 1990s, two-thirds of aircraft orders originated from these two regions; in earlier decades, the percentage was even higher. And because the American and European economies are so tightly linked, aircraft demand ebbed and flowed simultaneously, exacerbating the severity of the aerospace cycle.

This time around, though, it's different.

A third region of demand has emerged: Asia and the Middle East, driven by their fast-growing economies. In recent years, aircraft orders out of Asia and the Middle East have combined for nearly one-third of total orders, while the concentration of orders from North America and Europe has declined to less than one-half. Even better, demand from these various regions is now much less in sync.

The result: a longer-lasting supercycle, likely to extend to 2011 or beyond.

Not only does more diversified geographic demand mean that the up cycle will likely be prolonged -- perhaps as long as eight years -- but also that the inevitable downturn, when it does come, will be less severe.

So, can triple-digit oil prices or a U.S. recession derail the aerospace supercycle? Not quite.

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At time of publication, Norton was long Boeing and Spirit AeroSystems, though positions may change at any time.

Charles L. Norton, CFA is a principal of GNI Capital, an equity long/short money management firm that provides investment management services to institutional clients including mutual fund sponsors, trust companies, investment advisory firms, corporate retirement plans and family offices. Mr. Norton is responsible for portfolio management and investment research for all of the company's managed assets, including the Vice Fund (VICEX) and the Generation Wave Growth Fund (GWGFX). Previously, Mr. Norton had been a vice president in the equity research department of a New York-based hedge fund, where he also managed separate long/short equity accounts. Prior to his experience on the buy side, he was an investment banking analyst at Smith Barney. He has a bachelor of science in management degree in finance from Tulane University's A.B. Freeman School of Business, and is a CFA charterholder. He is a member of the CFA Institute and the CFA Society of Dallas-Fort Worth. While Mr. Norton cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.