Defense bonds: risks and opportunities amid an uncertain geopolitical and macroeconomic environment. Defense bonds: risks and opportunities amid an uncertain geopolitical and macroeconomic environment. Defense bonds: risks and opportunities amid an uncertain geopolitical and macroeconomic environment.

Defense bonds: risks and opportunities amid an uncertain geopolitical and macroeconomic environment.

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  Adding exposure to the defense sector might offer stability and long-term spread compression as global security concerns escalate. Yet, since Russia invaded Ukraine in 2022, defense bond spreads have tightened significantly, offering a modest or even, in the case of junk defense bond space, a negative pickup over peers. Compared to investment-grade corporate averages, defense bonds have higher leverage and lower interest coverage but pay a yield of 5.4%, in line with the IG average. On the other hand, junk defense bonds have slightly higher leverage but almost double the investment coverage of the broad junk bond space. Hence, they are paying a yield of 6.6%, roughly 120bps below the broad high-yield corporate bond average.


History books will remember this week as Sweden cleared its final obstacle to join NATO after Hungary's parliament approved the Nordic country's accession. The 2022 Russian invasion of Ukraine has put into motion a series of events that are bringing an end to 200 years of neutrality in Sweden.

Ever since the Russian invasion of Ukraine, western governments have increased military spending substantially, reaching a record €240 billion in Europe last year. Such a move is propelling defense stocks higher, and the Invesco Aerospace & Defense Portfolio (PPA:arcx) has risen by 37% since February  2022 until today, while the VanEck Defense UCITS ETF (DFEN:xetra) has increased by 43% since inception (April 2023).

Why consider bonds in the defense sector?

As geopolitical tensions are unlikely to decline in the foreseeable future, the defense sector will continue to attract investments, creating opportunities for stock and bond investors.

Diversifying one portfolio into the defense sector might prove valuable because:

1. It offers stability. The defense sector is known for its stability, even during economic downturns. Governments worldwide allocate a significant portion of their budgets to defense spending, which provides a steady stream of revenue for defense companies.

2. It is heavily exposed to technological advancements. The defense sector is often at the forefront of technological advancements. Defense companies invest heavily in research and development to develop cutting-edge technologies like cybersecurity, artificial intelligence, and advanced weaponry. Investing in the defense sector allows investors to participate in the growth potential of these innovative technologies.

3. It has the potential for long-term spread compression due to increasing global security needs. As countries modernize their defense capabilities and adapt to new threats, defense companies will likely benefit from sustained demand for their products and services.

4. Global security concerns are escalating. With geopolitical tensions in Ukraine and Israel, governments must continue investing in defense capabilities, making it a contemporary theme in one portfolio.

Defense corporate bonds: threats and opportunities.

At the bottom of this piece, you will find a list of defense investment-grade and high-yield corporate bonds available on the Saxo platform. Depending on the credit rating, maturity, and coupon of each bond, the risk-reward profile of an instrument will change. However, when considering what bond to pick, it is important to keep the following in mind:

1. High-yield defense bonds spread over US Treasuries are the tightest on record. High-yield defense bonds pay 154bps over their US Treasury benchmark. Yet, the picture changes dramatically when we compare high-yield defense bonds with the broad junk bond averages. Indeed, US dollar defense junk bonds pay -120bps below the US high-yield average, a level that we hadn't seen before the war in Ukraine started since the Global Financial Crisis (GFC). That means that while, on average, US dollar junk bonds pay a yield of 7.8%, defense HY bonds pay just 6.6% in yield. On the contrary, investment-grade defense bonds pay an average yield in line with the IG average, around 5.4%.

Bullish sentiment in junk defense bonds might be spurred by improving fundamentals. US high-yield defense bonds have a higher interest coverage compared to investment-grade defense bonds and a leverage in line with investment-grade peers (see chart below).

2. Maturities within the defense sector will pick up only in the second quarter of 2025. That means that this sector will be less exposed to refinancing risk. As central banks are preparing to begin cutting rates this year, companies might be able to refinance existing debt on better terms compared to today, putting less strain on their balance sheets.

3. Interest rate risk remains a threat. Corporate bond valuations include an interest rate spread and a corporate spread. While the corporate spread relates to the health of a specific company, interest rates relate to monetary policies. Therefore, if benchmark rates are rising, corporate bond positions might incur losses even if the balance sheet of a specific company is improving, causing corporate spreads to tighten. That's exactly what happened in the past couple of years: corporate bond spreads have collapsed, but the Federal Reserve's hiking cycle has put upward pressure on yields, causing losses across fixed income space. The good news is that the tightening cycle has peaked, according to central banks on both sides of the Atlantic. That should be broadly supportive of fixed-income securities. 

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article

Disclaimer

The Saxo Group entities each provide execution-only service, and access to analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular, no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Trading in financial instruments carries risk, and may not be suitable for you. Past performance is not indicative of future performance. Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

Singapore
Singapore

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.