Money Alone Can't Fix America's Arsenal ProblemBy Joel Litman, chief investment officer, Altimetry
 A massive defense budget is colliding with multiyear production delays...
America is on track to spend roughly $1 trillion on military technology this fiscal year. Yet key inventories have reached dangerously low levels. The shortfall includes the interceptors used to destroy incoming aircraft and missiles, and long-range precision weapons. Recent military operations in the Middle East have put even more pressure on those reserves. And replenishing them is a painfully slow process. Even an immediate funding surge wouldn't close the gap fast enough. The Pentagon would have to wait at least two years before fresh missiles roll off production lines. The main constraint is physical capacity... There just aren't enough factories and suppliers. There's also a shortage of weapons machinery and skilled labor. Today, we'll explain how decades of lost industrial capacity created today's munitions shortage and how investors could benefit from a manufacturing rebuild at home. The U.S. weapons shortage was decades in the making...The defense drawdown had already begun in the 1980s, as Cold War tensions eased. And the Soviet Union's collapse in 1991 accelerated it. The Department of Defense ("DOD") budget fell roughly 40%. The Procurement budget took an even bigger hit... dropping 71% in that same period. America's weapons makers received far fewer orders. Production lines slowed. Suppliers lost business. And factories cut their storage capacity for munitions. The military head count also shrank alongside the budget. By 1997, active-duty personnel fell roughly one-third below 1988 levels. The DOD budget decreased about 30% over the same period. Our defense budget is only as useful as our industrial capacity...Roughly 40% of the Pentagon's spending goes toward new weapons, modernization, and rebuilding low inventories. And as we mentioned, production is the main constraint. The U.S. spent decades shrinking its defense industry. China, on the other hand, expanded the industrial base behind its military...
China is adding advanced weapons and military equipment at 5 to 6 times the U.S.'s pace. China also has roughly 230 times as much shipbuilding capacity as the U.S. by gross tonnage. That doesn't mean China produces 230 warships for every one American ship. But it does show how massive China's manufacturing infrastructure is... And how much work the U.S. needs to do to catch up. Replenishing our arsenal means rebuilding our defense industry... The U.S. can't solve its weapons-shortage problem with increased spending alone. It needs a sustained rearmament strategy. Defense companies require a steady stream of orders to commit to new manufacturing plants. The Pentagon also needs larger inventories... Every new conflict can't immediately cause a production bottleneck. China has demonstrated its tremendous industrial capacity. And the U.S. is being forced to build the same. As we restore our arsenal, the entire defense supply chain will feel the effects... from the largest weapons makers to the companies supplying the parts that keep production lines moving. This presents a good investment opportunity. Be on the lookout for companies that will reshape the defense industry and its supply chain... or be affected by them. These include manufacturers, manufacturing-equipment providers, and the businesses that power that machinery. Regards, Joel Litman
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