As Trade Troubles Brew, Defense Stocks Guard Industrial Fort

(Bloomberg) -- U.S. aerospace and defense stocks kicked off this year under a cloud of uncertainty, amid concerns around a possible peak in spending and a prolonged government shutdown, yet nearly half way through, they are raking in the biggest returns among industrial companies.

The S&P 500 Aerospace & Defense Industry Index has risen over 20% so far in 2019, exceeding the 16% gain in the broader industrials sector group. The biggest gainers on the defense index this year include L3 Technologies Inc. and Harris Corp., each up more than 46%, as well as TransDigm Group Inc., with its 38% advance.

“Defense stocks have been winners this year with geopolitical tensions, trade wars, and a renewed focus by the Trump administration to prioritize defense spending,” said Rohan Reddy, an analyst at Global X ETFs. The analyst via email said that he expected the strength in defense stocks and domestically focused industrial companies to continue if trade negotiations keep getting dragged out.

The back and forth on trade has continued, with latest reports suggesting the U.S. was considering delaying the threatened Mexico tariffs as talks over the flow of undocumented migrants and illegal drugs from Central America were ongoing.

While the U.S. government has opened trade wars on multiple fronts, impacting companies across industries such as automotive, manufacturing and transportation, it has also worked on a major arms deal with Taiwan, and stepped up its involvement regarding Iran. Last month, President Donald Trump agreed to send more troops to the region after the U.S. blamed Iran for attacks on Saudi oil installations as well as four ships.

In a note published earlier this week, Buckingham analyst Richard Safran said the market might be ignoring macro factors that favor the defense sector, which include a continued demand for defense products that is driving government spending beyond expectations, a declining 10-year yield making corporate dividends seem more attractive, and lastly, tariff-related fears sparking a flight-to-safety trade.

Meanwhile, transports have languished. Airlines have been beaten down the most, amid rapidly fluctuating oil prices, slowing domestic demand and the fallout from the twin fatal crashes that led to the grounding of Boeing Co.’s 737 Max jets. However, railroad companies and truckers have not been spared either, with demand softening and the possibility of a Mexico tariff creating further uncertainties.

“Transport stocks are a high risk/reward investment in today’s environment,” Global X’s Reddy said, adding that such companies will continue to be volatile as trade negotiations take place. “Airlines are likely to face challenges in the near term” as margins keep compressing, “although lower commodity prices may provide temporary relief,” Reddy added.

The S&P 500 Airlines Industry Index has risen just 4% this year, with American Airlines Group Inc. and United Continental Holdings lagging the most.

To contact the reporter on this story: Esha Dey in New York at edey@bloomberg.net

To contact the editors responsible for this story: Brad Olesen at bolesen3@bloomberg.net, Jeremy R. Cooke, Morwenna Coniam

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