Facebook Twitter



Sell swords, buy plowshares.

That's the unhedged advice of Wall Street's top expert on defense companies, as President Bush and Mikhail Gorbachev prepare for another love feast at the summit.What's more, George D. Shapiro tells me, the cut in U.S. defense spending is likely to be startlingly large in the next two years - down to its lowest share of the economy in 42 years.

Shapiro, the crack aerospace analyst for Salomon Brothers, has won his No. 1 position by combining shrewd observation with rare candor and courage, and all those qualities were in evidence when he took his latest look at the companies he covers.

When I asked him why, with peace apparently the happy prospect for the world, anyone should buy defense stocks today, Shapiro instantly replied: "I agree with that - I wouldn't recommend anybody buy any of them."

Such bluntness is not only unusual in Wall Street, it is unusual anywhere in this mealy-mouthed era. And Shapiro's willingness to speak so sharply about major American corporations is particularly significant after the recent scandal in which a casino analyst was forced to resign by a Philadelphia firm after his criticisms offended the mighty Donald Trump. That firm should be ashamed of itself, and so should any outfit that is tempted to substitute expediency for honest service to the customer.

That's obviously not a problem for Shapiro, who when he spoke to me early last year was devastatingly on target with his recommendations both to buy (United Technologies and Boeing) and to sell (Grumman, G.M. Hughes and Lockheed). This analysis, remember, occurred before the "surprising" events in Eastern Europe. Those dramatic changes have made him even more convinced that the U.S. defense industry has deep troubles ahead.

Specifically, Shapiro expects "real" defense spending - that is, with the nominal numbers adjusted for inflation - to be reduced by close to 10 percent annually for at least the next two years. And he sees the defense share of gross national product, our overall economy, tumbling from 5.7 percent to below 4 percent.

For perspective, the defense share of GNP was as high as 11.9 percent in the first year of Dwight Eisenhower's presidency before starting a bumpy descent (interrupted, but not reversed, by Vietnam) to 4.7 percent under Jimmy Carter. Ronald Reagan's buildup temporarily reversed the trend, taking the defense share of GNP to 6.3 percent. A severe reduction over the next couple of years to below 4 percent, which Shapiro now foresees, would bring the defense business to its lowest share of the American economy since 1948 - when, in the euphoria that briefly followed World War II, we dreamed of a permanent peace.

Is the current trend a similar case of wishful thinking? "Well, I think nobody really knows for sure," says Shapiro. "I think what is clear is that the defense budget is going to go down significantly this year and next year. I look for close to 10 percent real declines in the budget this year and next year, and then maybe some reassessment as to where we really are and have we overdone it."

Along the way, he's convinced that defense stocks will be notable laggards, with their dividend yields having to rise substantially before buyers will be attracted. Not only would he avoid buying any of these companies, he would even aggressively sell some of them, such as E-Systems and Loral, short. (My usual caution that even a smart guy like George Shapiro could occasionally be wrong is doubled for those tempted to sell short, one of the market's riskiest activities.)

But while Shapiro is profoundly negative on the defense companies, he is still bullish on the commercial aircraft cycle. Indeed, his old favorite, Boeing, actively benefits from peace - since defense contracts represent only 25 percent of its business, and a money-losing part at that. He also likes United Technologies and Sunstrand, a subcontractor with a virtual monopoly on constant-speed drives for airplane engines.

At least until the world turns again, though, he believes, the major defense contractors will have to accept that "if you're a General Dynamics and you're a $10 billion company today, you'll be a $7 billion company in three or four years." Peace, for which every rational person yearns, will take some casualties of its own.