A few years ago, the U.S. was waging war on two fronts and demanded a sharp rise in federal defense spending. At that time, with the global economy largely on the fritz, military contracts drove the bulk of the growth in the aerospace industry.

But defense spending is now on the decline. Downsized U.S. military operations and proposed budget cuts tied to sequestration are raising questions about impact on aerospace contractors, and how well the industry is poised to handle such changes.

The trend will likely lead to a significant slowdown, according to analysts, particularly for companies on the lower end of the supply chain. Contractors specializing in parts for weapons systems and military aircraft will probably get hit hardest, experts say.

But even large contractors likeLockheed Martin ( LMT ),Raytheon ( RTN ) andNorthrop Grumman ( NOC ) are feeling the pinch.

"There has already been an impact on the big, prime contractors," said Richard Whittington, aerospace analyst at Drexel Hamilton. "Their revenues have stopped going up, they have reduced head counts and internalized some manufacturing that was previously outsourced."

A Commercial Break

On the positive side, companies that get a large part of their revenue from the commercial aircraft sector are seeing increasing benefits as airlines boost spending and race to buy newer, more fuel-efficient planes.

These include top names likeBoeing ( BA ),BE Aerospace ( BEAV ) andEmbraer (ERJ).

"The companies with more diverse portfolios, who have significant investments in the commercial side, are doing well because that side of the industry is going gangbusters right now," said Dan Stohr, a spokesman at the Aerospace Industries Association. "Southwest Asia is a huge growth market for commercial airlines, and demand is still going quite strong there."

According to a report from PricewaterhouseCoopers, the aviation industry last year delivered a record 1,189 large commercial aircraft. That was up 18% from 2011, which was also a record year.

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Aerospace And Defense Firms See Shift In Market Cycle