Despite ongoing geopolitical tensions in the Middle East, the U.S. defense sector has not strengthened as some investors had expected. Share prices of major defense contractors have generally fallen between 13% and 26%. As of early June, Lockheed Martin (LMT) had dropped approximately 13%, Northrop Grumman (NOC) had fallen more than 20%, and Raytheon Technologies (RTX) also recorded a double-digit decline, sliding about 26% over the period. Although the U.S. Congress is still discussing increases to the defense budget, and the Trump administration has proposed a defense spending plan as high as $1.45 trillion, the overall performance of the defense sector has been significantly weaker than the broader market.
In a research report released on June 2, Bernstein analyst Douglas Harned stated that the decline in defense stocks is primarily due not to a worsening of industry fundamentals, but to sector rotation of market capital. At the onset of the Iran conflict, defense stock valuations were already near historical highs, making the sector particularly vulnerable as investors shifted toward high-growth opportunities. As investors turned their attention to sectors such as technology and consumer goods, which offer faster revenue growth, capital continued to flow out of defense stocks. Nevertheless, the magnitude of this sell-off still exceeded Bernstein’s earlier expectations.
Bernstein believes the fundamentals of the defense industry remain solid. However, at current valuation levels, defense stocks have become significantly less attractive to investors seeking higher revenue growth opportunities. The firm maintains its “solid” assessment of industry fundamentals but acknowledges a lack of near-term catalysts strong enough to reignite market enthusiasm. This situation is unlikely to change before the midterm elections in November. The biggest issue at present is that no powerful catalyst is in sight to inject new momentum into defense stocks before the elections.
Another layer of market concern is that if the Democratic Party wins a majority in one or both houses of Congress, it might push for cuts in defense spending. In response, Bernstein points out that historical experience suggests that, amid persistently high geopolitical threats, which party controls Congress has a negligible actual impact on the defense budget. Investors may be overestimating the political risk posed by the elections.
From a longer-term perspective, Bernstein maintains a positive stance on the defense sector. Even if Congress ultimately scales back Trump’s proposed $1.45 trillion defense plan, the firm still expects defense spending to rise further from current levels. In the short term, defense stocks are under the dual pressures of a “catalyst vacuum” and capital rotation, and the sector is unlikely to see a trend-driven opportunity before the midterm elections.
