Interview – May 11, 2006

HDS: Hi this is Ann Marie Fleming with HomelandDefenseStocks.com

HDS: In today’s discussion with Scott Sacknoff, manager of the SPADE® Defense Index (AMEX: DXS), we will be discussing if it is possible to time investments in defense and homeland security and how do they think the sector will perform going forward. We will also inquire his thoughts on the recent protests regarding immigration in the U.S. and what effect it will have on investments in homeland security.

HDS: Mr. Sacknoff, good afternoon.

SMS: Good afternoon, Ann Marie.

HDS: Before we get started, how are investments in homeland security and defense performing?

SMS: Well Ann Marie, year-to-date, the SPADE® Defense Index is up nearly 11.75% and it is once again outperforming the broader market by several percent. During the last month, the Index also passed the 2000 level for the first time and the exchange traded fund (AMEX: PPA) that tracks this Index has seen an inflow of assets into the fund bringing the fund to more than $90 million.

HDS: Our readers are always looking to identify the best time to make investments in the sector. You’ve recently done some research analyzing the performance of the SPADE Defense Index. Can you tell us what you’ve learned?

SMS: Economists and industry analysts are paid to forecast the direction of the market or a business sector, but they will be the first to tell you it is all just an educated guess. Like these professionals, we routinely get questions inquiring if one compares an investment in homeland security and defense to that of the overall market, when is the best time to buy and how do we think the sector will perform going forward. Now, since I am an index manager and not a registered securities broker, I do not give advice on individual companies.

However, there are four things that investors should keep in mind when trying to time an investment in the sector.

1. Obviously, the biggest revenue impact to companies operating in this sector comes when the federal budget is released and when those details become public in late January/early February. While it may not necessarily have an impact on near-term, in other words, the next quarter’s revenue and income, the market tends to move on the guidance that the federal budgets for the Department’s of Defense and Homeland Security and NASA offer regarding the longer-term, multi-year prospects of the sector.

2. Independent of the budget forecast, during the course of the year individual companies report a variety of news that will impact their revenues and earnings. This could take the form of commercial sales to non-governmental customers, new contracts, or the acquisition of smaller players. When it comes to acquisitions, many midsize and large contractors routinely look at smaller players to expand their markets, acquire access to long-term contracts, and (hopefully) improve revenues and earnings. Though many are smaller deals that don’t make the mainstream news, the sector sees several hundred mergers and acquisitions annually driven by the government’s continued desire to fund small technology and service companies. Even in a flat budget environment, it is possible for companies to grow.

3. The defense and homeland security budget is a top-level figure. Underneath it are dozens, if not hundreds, of individual markets, some that may rise even if the overall budget declines. For example, IT services are critical to homeland security operations and DoD initiatives that seek to achieve a network centric warfare vision. Likewise, continued spending on armor to protect the lives and health of soldiers and the safety of equipment is not an area that will likely see a dramatic decline as long as our country puts people in harm’s way.

4. Regarding the performance of the index following major terrorist actions, we have not be able to identify any specific bounce attributable to actions such as the train bombings in Spain and London, although stocks in several companies individually did react. When looking at the days following 9/11, the Index saw minimal action but did post double-digit gains in each of the next two quarters before falling with the broader market. For individual companies and the Index as a whole, these incidents have increased the focus on the sector, and in turn, its performance--but an immediate short-term bounce on reaction is not as clear to define.

So when is the best time to put money into the sector?
We based the following looking solely at the performance of the SPADE Defense Index on a quarterly basis. Instinctively, one would think that the 1st Quarter would see the best returns since the President’s budget proposal is released in February. In fact, the 3rd Quarter is the only quarter that has outperformed the S&P500 in each of the last six years. This quarter typically sees the official signing of the budget, after Congress has reviewed and made changes to it, along with the government announcing the signing of a number of signed contracts with companies. While this may not be the main reason, it is our educated guess.

For those that fear trying to time the market, they should note that over the last eight years, the SPADE Defense Index has seen a gain in all four quarters once, in three quarters once, and in two quarters the other six times. In 33 quarters of data, the Index has been up 20 times and down 13.

Perhaps the best statistic for long-term investors, is that in these 33 quarters, the Index has never
declined for more than two quarters in a row and every calendar year when the Index had a quarter with a double-digit decline it also had a quarter with a double-digit gain.

HDS: Immigration has been a hot topic of discussion over the past few weeks as large rallies have taken place in cities across the United States and Congress debates immigration-related policies designed to improve the security of our borders. What do you think about this and its effect on the business of homeland security?

SMS: First of all, from what I’ve seen, the media has misrepresented much of the issue. As Congress considers whether to make being caught in the U.S. illegally a felony crime and people call for more efforts to secure our borders and prevent easy access into our country, they are doing so more out of economic fears than security reasons. The recent demonstrations were as much to raise the visibility of legal immigrants and the role they play in the economy as to protest what Congress is considering. Lest we forget that the 9/11 terrorists arrived in the U.S. on visas legally. Tightening the borders and throwing people in jail would not have prevented this.

Regardless of whether we keep the current immigration system, restrict immigration, or open up the borders completely and let everyone in, the key to improving overall security is better tracking and monitoring of those non-U.S. citizens we let into the country. Unlike the ports situation, the Department of Homeland Security is currently funding initiatives related to improving its information technology and reconnaissance capabilities to better identify and track ‘visitors’ to our nation. While things can change for political reasons, a reallocation or the provisioning of additional resources by Congress to new border initiatives appears unlikely until after DHS completes the projects they are currently working on.

HDS: Very interesting. Well thank you for taking the time today. We look forward to more insight the next time we chat.

SMS: You’re most welcome. For your clients interested in getting more information on the SPADE Defense Index, please visit http://www.spadeindex.com. Investors should note that the exchange traded fund trades under the symbol ‘PPA’ and historical data on the SPADE Defense Index can be found using the index symbol ‘DXS’.

Disclaimers: The information presented in this interview is for informational purposes and should not represent a solicitation or an offer to purchase an investment product. SPADE and the SPADE Defense Index are registered trademarks of the ISBC. Powershares is a registered trademark of Powershares Capital Management.


For More Information:

Dawn L. Van Zant - President
800.665.0411 – dvanzant@investorideas.com 

Ann-Marie Fleming – Corporate Development
866.725.2554 – afleming@investorideas.com