Today, let’s look at the investment landscape from a 30,000-foot perspective…so to speak. Welcome to my video interview with Richard Aboulafia, managing director of the aerospace consulting firm, AeroDynamic Advisory.

Since 1988, Richard has tracked aircraft programs, markets, and companies as an analyst. He also manages consulting projects in the commercial and military aviation field. Defense News has listed Richard as among the “100 Most Influential People” in the defense industry.

Below is a condensed transcript of our conversation. My video is a “deeper dive” that provides several charts and additional details.

The coronavirus pandemic wreaked havoc on commercial airlines, an industry that’s a leading economic indicator. Now that the pandemic is mostly over and economies are rebounding, are commercial air carriers rebounding as well? How long will it take the major carriers to get back to pre-pandemic levels of revenue and profitability?

The upward trajectory for the industry has remained consistent and we’re back to pre-pandemic levels. But the problem is, we’ve lost long-term ground.

Our latest estimate shows that in 2025, years after we’ve hopefully forgotten COVID, we’ll still be 11% impaired in the airline sector, relative to where we would have been, had none of this happened.

And then there’s the war in the Ukraine, which is delaying by a modest amount some of the recovery in international traffic, but thankfully, domestic markets are still on track.

Due to Russia’s invasion of Ukraine, the U.S. and major Western countries are planning to significantly increase defense expenditures. Doesn’t that make the major defense contractors good investment bets now? Or has this boost in spending already been factored into their share prices?

Since Russia’s invasion of Ukraine in late February 2022, there’s been a significant rise in the share prices of the major aerospace/defense contractors. But I think this share price appreciation has even more traction ahead.

We’re just coming to terms with the new realities of the geo-strategic environment. It’s clear that there won’t be a sudden, happy end to the Russia-Ukraine conflict. We’ll remain in a confrontational situation into the foreseeable future.

Also, China is not breaking with Russia. We face the nightmare scenario of the Western democracies confronting two authoritarian peer adversaries, for years to come. This is a human tragedy of untold proportions, but it also means much higher defense spending, for a long time. A lot of money will be coming into the defense industry.

It looks as if we’ve dodged a recession, but economic growth will decelerate this year as previous interest rate hikes exert a lagging effect. The aerospace/defense industry tends to be resistant to economic downturns, correct?

As the saying goes on Wall Street, defense is defensive. If you go back to, well, forever, and do a data chart that correlates defense spending with economic indicators such as recession years or debt levels, you’ll see zero correlation.

The only external factor correlated with defense spending is threat. That’s it, whether the threat is real or politically perceived. From the perspective of defense spending, that’s a guarantee of growth, especially moving forward, because we face several years of a serious military threat.

On the commercial side, for the first time in my experience, the industry has badly lagged the rest of the economy. It will be interesting to see to what extent the commercial recovery from the pandemic keeps going, even if there is a recession.

I’m betting that the commercial recovery will proceed, because the dynamics associated with the COVID-19 travel downturn were so profound, we’ll still see a recovery even if the economy begins to slacken.

Inflation is falling, but it still remains a threat. Many investors would be surprised to learn that aerospace/defense stocks provide an effective hedge against inflation. Please elaborate.

That’s a key point. The majority of defense contracts are cost-plus. Whatever contractors pay for labor, materials, energy, what have you, it gets reimbursed with a guaranteed profit margin on top.

On the commercial side, hard assets, especially mobile ones, are actually a pretty good hedge against inflation, too. You wouldn’t think that, but they work just fine that way. So broadly speaking, aerospace/defense is one of your best hedges against inflation.

Thanks for your time.

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John Persinos is the editorial director of Investing Daily.

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