Defense stocks are more than a recession haven

Manufacturers of fighter jets, battleships and missiles are usually one of investors’ best defensive havens when economies get shaky. This time around, geopolitical conflict and tension are making them key components in the offensive arsenal as well.
Normally, when a downturn erodes demand or some exogenous shock rocks the market, the US government budget, and particularly spending on the military, tends to remain stable. This makes stocks of companies such as Lockheed Martin Corp., Northrop Grumman Corp. and others attractive when fears of recession increase.
There are some risks, including a president who emphasizes social programs over defense. That’s usually balanced over time by an administration that seeks to build up the military. The pendulum never strays too far from the average defense spending, which has been 3.8% of gross domestic product over the past three decades. This gives defense companies steady, but usually not stellar, sales growth.
That’s changing at a magnitude that likely matches the sudden increase this year in the geopolitical risk profile. The arms orders are pouring in. General Dynamics Corp. announced on Aug. 25 that it would supply 250 Abrams tanks to Poland with a total price tag of about $1.1 billion. Northrop Grumman was contracted in August to bolster US missile defense systems, which could generate $3.3 billion in revenue. Lockheed Martin scooped up a $4.4 billion order in June to supply as many as 255 Black Hawk helicopters, including options, to the US and foreign militaries.
Nations are ramping up military spending as they watch Russia’s war against Ukraine. Even more unsettling is China President Xi Jinping’s increasingly close relationship with President Vladimir Putin of Russia, including the participation of Chinese troops in joint exercises being hosted by Russia. This only heightens concern over China’s recent display of military might around and over Taiwan when US House Speaker Nancy Pelosi visited the island in August.
The investor rush to defense stocks was an obvious move after Russia invaded Ukraine on Feb. 24. The stocks have all gained this year, although a bit unevenly. Pure-play companies like Northrop, Lockheed and Huntington Ingalls Industries Inc., which makes naval vessels, have all risen more than 18% this year. General Dynamics, which makes private jets in addition to tanks and nuclear submarines, has risen 11% and Raytheon Technologies Corp., which sells jet engines to Boeing Co. and Airbus SE as well as for miliary aircraft, has posted just a 5% gain.
These are stellar results compared with the 16% drop in the S&P 500 Index this year. So the stocks are no longer cheap, but the momentum on orders for military hardware is just getting cranked up.
“You can clearly make the case that you’ve got a possible upside surprise with spending on defense,” said Bill Stone, who as chief investment officer helps manage $18 billion at Glenview Trust Co. Stone bought Lockheed, Raytheon and General Dynamics in 2021 as a defensive play and is hanging on to them as revenue is poised to swell. “They’re not screaming buys anymore, but there’s definitely upside.” Investing in defense stocks can be controversial. After all, these companies make products that are designed to kill people or take out buildings and bridges.

—Bloomberg