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Defense Stocks Eye Best Month in Two Years on Geopolitical Tensions

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(Bloomberg)

(Bloomberg) -- Rising geopolitical tensions and a strong set of quarterly earnings have put defense stocks on pace for their best monthly advance in nearly two years. 

An index tracking the sector has gained 9.2% in July, the biggest jump since October 2022, and handily beating the broader S&P 500’s 1.1% climb. The top gainer in the S&P 500 Aerospace & Defense Index was engines and fasteners supplier Howmet Aerospace Inc., which closed up 23% for the month. 

The upswing came just as investors were aggressively rotating out of large technology stocks and into some of the laggards in the market, such as small-cap companies and non-tech sectors, which likely gave an extra boost to the defense rally. A pickup in military actions around the world also stokes demand for defense products, whose manufacturers benefit from their links to government spending. 

“The group has had multiple tailwinds driving it higher,” said Michael O’Rourke, chief market strategist at Jonestrading. On top of a shift in favor of value stocks and profit gains, “global conflicts have been on the rise,” he said. “The high barriers to entry due to the necessary government approvals and government contracts frequently allow these shares to garner premium multiples.” 

The other top gainers were defense contractors RTX Corp., Northrop Grumman Corp. and Lockheed Martin Corp., and naval shipbuilder Huntington Ingalls Industries Inc. The recently reported quarterly profit and revenue for all five topped expectations, highlighting the strength of demand.

Meanwhile, an analysis from Yardeni Research showed that factory production in defense and space rose to an all-time high in June, helping drive solid gains in US industrial production. 

“This manufacturing mostly stems from defense contractors and is highly technical; demand is also inelastic and not sensitive to interest rates because the US government is the buyer,” said Eric Wallerstein, the firm’s chief markets strategist. 

Though the defense index is trading at a record, gains for this year — about 15% — are still slightly behind the nearly 16% rise of the benchmark S&P 500.

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Between the war in Ukraine and the conflict in the Middle East, geopolitical tensions are showing no signs of easing. That can sustain demand for companies that make defense products like combat aircraft, missiles and weapon systems.  

“We expect the tense geopolitical landscape to remain a tailwind for defense stocks’ performance,” Wallerstein added.

--With assistance from Felice Maranz.

(Updates stock moves in second and seventh paragraphs, updates both charts.)

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