When President Barack Obama quipped this week that he was happy to inherit used Marine One helicopters, the remark did more than cast a cloud over a $9 billion contract to replace the aircraft fleet.

The rise in defense spending during the Bush years had made the sector a safe haven for investors, but the new administration and influential lawmakers already are pointing to new priorities and procurement practices that could challenge that status.

The Spade Defense Index of about 50 stocks has outperformed the S&P 500 over the past eight years, though it just squeaked ahead in 2008.

Scott Sacknoff, who manages the index, doesn't expect much near-term impact from the changes in Washington D.C., as the U.S. still must replace equipment on its multiple battle fronts overseas.

Bill Swanson, chairman and chief executive of Raytheon Co. (RTN) told analysts earlier this month that he expects the awarding of new contracts this year to go smoothly. With Secretary Robert Gates continuing in the top defense post, and most of the new administration's team in place, "this transition is as smooth as I've seen," he said.

The Obama administration's five-year plan, expected later this year, will provide clearer guidance as to what might change.

"The important figure to look at is research and development, plus procurement," Sacknoff said of a figure now around $175 billion, out of a total budget of more than $5 billion. "That's the money that goes to companies."

Obama already has signaled some broad changes, including an end to no-bid contracts, "Cold War-era weapons systems" and a Marine One replacement program he described as "procurement gone amok".

Gates is expected to flesh out the details of the President's plans, although an exact date hasn't been set. Gates has backed a "75% solution" rather than 100% upgrades to existing programs, cutting back on expensive technology that may not be fully operative for years.

 
   Congress Gets Serious About Defense Cuts

Sen. Carl Levin, D-Mich., chairman of the Senate Armed Services Committee, and Sen. John McCain, R-Ariz., plan to begin hearings next week to address excess defense spending.

McCain, the former presidential candidate, has called the defense budget a "train wreck" filled with bloated programs.

U.S. Rep. Barney Frank, D-Mass., who heads the House Financial Services Committee, said this week that it would make sense to cut the defense budget by 25%, freeing up funds to be used for domestic stimulus spending.

McCain and Levin plan to introduce the Weapon Systems Acquisition Reform Act of 2009. Levin pointed to government statistics showing that spending for the top 95 defense programs last year ballooned by $300 billion from the original program estimates.

The proposal could cause serious transfer of risk back to defense contractors, said Howard Rubel at Jefferies & Co.

The key is to be sure costs are verifiable and controllable, Rubel said. The system that has been used since World War II caps the profits that defense contractors can make, although many contracts grow over time.

Sacknoff cautioned that even if some programs are cut, they may be expanded in the future, for political or practical reasons. In any case, he said, the prime contractors tend not to change, since other companies don't develop the same expertise to compete on long-range projects.

Levin has singled out the U.S. Army's Warfare Information Network, a communications program, and the Navy's Littoral Combat Ship program, with a budget that has doubled to more than $500 million a vessel. The Army program is led by General Dynamics Corp. (GD) and Lockheed Martin Corp. (LMT). Lockheed and Northrop Grumman Corp. (NOC) are key players making Littoral ships.

While contractors await the five-year plan, some say that the diversity of their businesses protects them from cutbacks on individual programs.

Lockheed Martin Corp. (LMT), the prime contractor on Marine One, and the Pentagon's largest supplier, for the first time this year will generate more revenue from its technology and international business unit than from traditional defense spending.

-By Ann Keeton, Dow Jones Newswires; 312-750-4120; ann.keeton@dowjones.com