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Following attacks that left at least 800 Israelis and an estimated 12 Americans dead, Israel is at war with the terrorist organization Hamas.
The attack, which occurred at the Supernova music festival, stirred swift response from Israel with that country ordering a “full siege” of Gaza. That started with massive air assaults and as of late Monday, roughly 300,000 IDF soldiers were gathered along the Israel/Gaza border, stoking speculation that an all-out ground assault is in the works.
Clearly, that loss of life is a tragedy and the toll could easily increase in the coming days, but as advisors and experienced investors know, financial markets continue functioning against the backdrop of geopolitical volatility. Perhaps surprisingly, the S&P 500 closed higher Monday, but not surprisingly, the MSCI Israel Index closed lower by 7.11%.
Also in the not surprising camp was oil’s Monday pop, largely attributable to Hamas sponsor Iran being a member of the Organization of Petroleum Exporting Countries (OPEC). Put it all together and it wouldn’t be surprising if some clients are asking advisors about aerospace and defense stocks and funds. A logical response to be sure, but not necessarily the best course of action.
Geopolitical Tumult Doesn’t Guarantee A&D Upside
Using the Invesco Aerospace & Defense ETF (NYSEARCA: PPA) as the gauge, aerospace and defense stocks provided responsive to the attacks, rising 4.11% Monday on volume that was more than five times the daily average.
I chose PPA because the ETF, which tracks the SPADE™ Defense Index, is old (it turns 18 years old later this month) and has good size ($1.89 billion in assets under management). It’s also home to familiar defense stocks, such as Northrop Grumman (NYSE: NOC), Lockheed Martin (NYSE: LMT) and Dow component Boeing (NYSE: BA).
Those names, among others, often prove responsive in the immediate aftermath of geopolitical upheaval. However, advisors might do well to do some narrative-busting with clients as it pertains to near-term exposure to A&D equities.
“First, there’s the idea that combat today leads to more future purchases of weapons manufactured by a given firm, making that company’s stock worth more,” according to Morningstar research. “This ignores how long in advance militaries procure weapons, and how they’re subject to strategic and political constraints. Second, there’s the broader narrative that sudden fighting in a geopolitical hot spot increases instability and defense budgets, and thus defense contractor revenue. This is more logically sound, but after the U.S. defense strategy pivot to great-power rivalry in 2017 and Russia’s invasion of Ukraine in 2022, we don’t see incremental upside to global defense spending.”
Iron Dome Not Iron Clad Investment Guarantee
Israel’s “Iron Dome” short-range missile defense system – funded in part by the U.S. – is likely to be in the news in the days ahead, but investors shouldn’t get excited about that.
The two companies with the most Iron Dome exposure RTX Corp. (NYSE: RTX) and BAE Systems (BAESF) – both generate less than 10% of sales from the Dome and BAE is a British company, so it’s not component in many US-listed A&D funds.
“And as seen in Ukraine, when combat depletes munition stockpiles, they will be resupplied from allies’ existing stockpiles, with zero impact on the manufacturer that previously delivered them. Eventual orders for more of the weapons may come if current production rates won’t refill stockpiles in time, but adding capacity is expensive and time-consuming, and thus not a bullish outcome in our view,” concludes Morningstar.
Bottom line: A new war in the Middle East may give short-term rise to A&D stocks and funds such as PPA, but clients shouldn’t bank on long-term upside for those assets simply because of near-term geopolitical chaos.