US defence stocks: new conflicts change little for arms groups

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The grim reality is that defence stocks generally rise during periods of geopolitical turmoil. Investors use them to hedge against sell-offs in sectors that are not underpinned by humanity’s tragic propensity for violence.

JPMorgan boss Jamie Dimon warned last week that conflicts in Ukraine and the Middle East are creating “the most dangerous time the world has seen in decades.”

Shares in big US military contractors, including Lockheed Martin and General Dynamics, have climbed 11 and 7 per cent respectively since October 6. That was the last trading day before a shock attack by Hamas on Israel set off massive retaliation on Gaza.

Northrop Grumman is up 15 per cent. L3Harris Technologies is 7 per cent higher. Even RTX, which has been hit by manufacturing problems in its jet engine unit, has gained 4 per cent as both institutional and retail investors bought in.

Even so, all five stocks are in the red for the year. On a forward earnings basis, valuations have barely budged. With the exception of Northrop, all are trading at or below their three-year averages.

There are good reasons for that. For starters, defence stocks have had a strong run in the wake of Russia’s invasion of Ukraine in February 2022, with many setting new highs.

At the same time, the link between conflict and US defence company profits are not straightforward.

Dysfunction in Congress is one issue. The House of Representatives remains without a speaker. Bitter partisan bickering over the size of government spending and America’s obligations to help Ukraine have threatened to shut down the government.

Russia’s challenges to Europe and Chinese sabre-rattling against Taiwan will nevertheless bolster military budgets. However labour shortages, supply chain disruption and drawdown of inventories can all reduce gains to arms groups.

But it is the character of warfare rather than its incidence that matters most to the defence sector. Savage fighting has little impact if it is shortlived and localised, or characterised by insurgencies.