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The Battle of 2014: A shrinking defense industry

A U.S. Navy Aviation Boatswain's Mate signals to launch an F/A-18E Super Hornet aircraft from the flight deck of the aircraft carrier USS George Washington (CVN 73) in the South China Sea
Source: U.S. Department of Defense
A U.S. Navy Aviation Boatswain's Mate signals to launch an F/A-18E Super Hornet aircraft from the flight deck of the aircraft carrier USS George Washington (CVN 73) in the South China Sea

The Pentagon has survived the Battle of 2013: sequester, furloughs and even a government shutdown. However, 2014 could make 2013 look like a mere skirmish. The good news is that defense contractors have been battle-tested and are adept at working through downturns. In fact, if only some defense programs had as few hiccups as company balance sheets.

Job cuts won't slow down.

Defense companies continue to try to stay ahead of budget cuts with cuts of their own. Lockheed Martin alone has reduced its workforce by 20 percent since 2008, with more cuts and closures planned over the next year. This won't be the end of it. As one analyst said, in 2013 the Pentagon managed to make up for the sequester by finding "loose change in the couch." All that loose change has been spent. The Department of Defense estimates its budget for the fiscal year will be $628 billion, down from $676 billion last year. It is projected to fall another $24 billion next year. Goldman Sachs believes we are closer to the bottom than the top of the budget cycle and that "margins will prove much more resilient than expected." One way to keep those margins resilient is to cut personnel.

(Read more: 2014—The year the economy clicks)

It'll be Navy over Army.

The Navy has not been as nearly as essential over the last dozen years of war as the other services, but that is changing. As China's first aircraft carrier weighs anchor just as that country flexes its muscle in the South China Sea, look to see the U.S. Navy become more of a funding priority. Even the troubled and expensive Littoral Combat Ship (LCS) by Lockheed Martin may stay afloat. The first LCS has been on its maiden voyage in the South Pacific, and the Navy hopes to buy 52 in all. Despite satellites and drones and long-range aircraft, most of the world's trade goes by water, and whoever rules the waves rules the world.

(Read more: Poll: Advisors primed for a 10 percent drop next year)

Space agency will start spending again.

This is my riskiest prediction. NASA has been fighting for dollars for a long time. This has pushed the space agency to change its business model and shift away from contracting with traditional players for big, expensive projects, opting instead to buy more off-the-shelf products and services from companies like SpaceX and Orbital Sciences. However, China (yes, China again) has just launched a rover to the Moon with plans to put humans there by 2025–2030. I predict Congress will rethink its reluctance to fund space exploration once Americans look up in the sky at night and realize China could surpass us. New spending by the space agency could benefit traditional partners like Lockheed Martin, Boeing and ATK.

(Read more: Wall Street: The day of reckoning nears)

—By CNBC's Jane Wells. Follow her on Twitter @janewells.


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