QUOTE
We view the rally in defense stocks as an exaggerated reaction to news of renewed conflict in the Middle East. As we have pointed out before, the dots between military combat and the profit of a defense contractor do not connect nearly as directly as investors seem to imagine.
Armed conflict does not necessarily benefit defense contractors fundamentally, especially if the conflict is prolonged and expensive.
In the short term, munition resupply orders can add to sales, though these are not usually big relative to total revenue. However, a drawn-out conflict could sap military budgets and divert funds to operations and logistics from research, development, and procurement, where defense contractors make the bulk of their money.
Other than as a tactical rotation to a sector generally insulated from macro shocks, such as the oil price spike that also accompanied the Israel-Iran news, we hear two narratives to justify snapping up defense contractors. Neither holds much fundamental water, in our view.
First, the idea that combat fuels more purchases of weapons made by a given firm and makes that company’s stock worth more ignores how long in advance militaries procure weapons, which is subject to strategic and political constraints. Second, there’s the view that increased geopolitical instability broadly stimulates defense budgets, and thus defense contractor revenue is more logical. Still, we don’t see incremental upside to global defense spending from the super cycle we already forecast.
That's good to know.
What was the last thing you thought?, general edition
Jun 11 2025, 02:44
