Middle East Conflict Impacting Defense Contractors

The ongoing conflict in the Middle East is having a significant effect on the stock market, particularly for defense contractors. With tensions rising, it's crucial for investors to assess potential winners and losers, as well as consider the likelihood of the Israel-Hamas war escalating further.

Over the weekend, Hamas militants launched a multi-front assault on Israel, deploying land, sea, and air attacks. Israel responded by declaring war on Hamas and launching retaliatory strikes. This escalation in violence has resulted in a surge in shares for defense contractors.

Established industry giants such as Lockheed Martin (ticker: LMT) and Northrop Grumman (NOC) have seen their shares surge by 4.9% and 4.3% respectively during premarket trading on Monday. Likewise, General Dynamics (GD), L3Harris Technologies (LHX), and Huntington Ingalls Industries (HII) have experienced respective gains of 3.2%, 3.2%, and 1.6%. RTX shares (RTX) are also up by 4%. Surprisingly, Boeing shares (BA) have remained flat.

On the other hand, the smaller defense stocks display a more mixed response to the conflict. Kratos Defense and Security Solutions (KTOS) and BWX Technologies (BWXT) have witnessed increases of 3% and 0.7% respectively. However, Mercury Systems (MRCY) shares have declined by 1.8%.

Although defense contractors have seen a positive impact on their stock prices, the broader market has not fared as well. Both S&P 500 and Dow Jones Industrial Average futures have experienced declines of 0.5% and 0.4% respectively.

Overall, this surge in defense contractor shares has collectively raised the market capitalization of these stocks by $15 billion, bringing the total to approximately $500 billion. As the Middle East conflict unfolds, investors will need to closely monitor these stocks and assess further developments.

Investing in a Time of Conflict

The current conflict has left investors seeking guidance, but finding few on Wall Street willing to offer their input. As uncertainty hangs in the air, the duration and extent of the conflict remain key questions. If the skirmish is resolved quickly and remains contained, defense shares may experience a retreat from their recent gains.

Beyond the conflict, investors are also carefully considering the potential impact of a U.S. government shutdown on the defense sector. Interestingly, historical data suggests that previous shutdowns have had minimal effect on defense stocks.

Unfortunately, defense shares have not been strong performers of late. Among large-cap stocks, only Boeing has seen an increase in value over the past 12 months. However, it should be noted that Boeing is primarily regarded as a commercial-aerospace company by investors. In contrast, the average performance of other defense stocks has seen a decline of approximately 14% over the same timeframe, while the S&P 500 has enjoyed an increase of about 19%.

These drops have resulted in defense stocks (excluding Boeing) being traded at a multiple of around 14.5 times estimated 2024 earnings, a decrease from the historical average of approximately 17 times in recent years. It is worth mentioning that Boeing's earnings still suffer from the aftermath of the Covid pandemic and the issues surrounding the 737 MAX, causing its stock to be valued at around 38 times estimated 2024 earnings.

Although investors are keen for insights and predictions during these uncertain times, it appears that information from Wall Street remains scarce. However, evaluating the potential effects of a government shutdown and observing the performance of defense stocks can provide investors with valuable knowledge during this tumultuous period.