The Israel-Gaza conflict erupted into a war after an attack by Hamas and retaliation by Israel.
Shares of defence stocks including Northrop Gruman (NYSE: NOC), L3Harris Technologies (NYSE: LHX), Huntington Ingalls Industries (NYSE: HII), Lockheed Martin (NYSE: LMT) and General Dynamics (NYSE: GD) led gains in the S&P 500 Index on Monday. The stocks each gained at least 8% in the session, the most in more than three years.
The iShares U.S. Aerospace & Defence ETF (BATS: ITA) increased by 4.4% during market trading and another 1% after hours.
We wonder if defence stocks tend to do well during wars? Here, we take a look at how defence stocks performed in major conflicts that took place previously.
To be clear, we view violence in any form as a negative occurrence. A ceasefire and peaceful resolution would be the best overall outcome for the world as a whole.
1) 2022 Russia-Ukraine conflict
Most stocks fell at the onset of the Russia-Ukraine conflict except for defence stocks which started a bull run from that point.
In 2022, the Invesco Aerospace and Defense ETF (NYSE: PPA) index gained 8.6%, outperforming the broader U.S. market by 28%. This rise was led by Allegheny Technologies (+87%), Maxar Technologies (+75%) and Northrop Grumman (+41%).
Even with the broader U.S. market down nearly 20%, many defence stocks saw their share price increase by double digits in percentage.
In addition, investment funds have seen their assets under management grow significantly in the past 18 months, with the Invesco Aerospace and Defense ETF (NYSE: PPA) tripling to nearly $2 billion.
2) 2001 Afghanistan & 2003 Iraq
The 2001 Afghanistan war commenced in Oct 2001, shortly after the 9/11 bombings. At the onset, most stocks fell while defence stocks such as Lockheed Martin actually spiked up once the stock market reopened after 9/11.
Defense stocks outperformed the S&P500 index for three years running (2000, 2001 and 2002).
Similarly, in the lead-up to the Iraq War, which began in 2003, markets were highly volatile, with the Dow Jones Industrial Average falling by over 2,000 points in the first six weeks of the conflict.
However, following the start of the war, the Dow Jones index began to recover and experienced a rally that continued through the end of 2003, gaining more than 30% from its March 2003 low.
From the commencement of the war on Iraq in Mar 2003, the S&P’s Aerospace and Defense index almost tripled in the next 4 years, easily outstripping the S&P 500’s gains, as U.S. defense spending soared and a resurgence in travel demand spurred record aircraft orders.
2 Factors influence defence stocks’ outperformance
1) Increased government spending
The collapse of the Soviet Union in 1991 not only created a unipolar world with the U.S. as the only remaining military superpower but also changed the way policy makers and leading militaries thought about war and defense.
With the Soviet Union’s collapse in 1991 and no conflict in sight, U.S. policy makers quickly agreed to major cuts in the defense budget which led to the collapse of many long term government suppliers.
During the 1990s overall global military expenditures closely mirrored the decline of the U.S. defense budget, with Asia being the only exception. Although Japan, Korea and India likewise increased their defense spending, China was mainly responsible for the strong growth in Asian military expenditures.
The cuts in Western defence budgets came to an immediate halt with the events of 9/11. The threat of terrorism and the wars in Afghanistan and Iraq caused a global increase of defence budgets.
Similarly, US also wound down its defence budget, bottoming in FY15, before it increased in FY16, based on the need to modernize the force for the future and respond to emerging security challenges.
This led to the share price outperformance in the subsequent periods as mentioned above.
2) Economic conditions
Broader economic conditions, such as interest rates, inflation, or economic downturns, may indirectly influence defense stock prices. These factors may impact government spending, investor sentiment, and overall market conditions.
Imbalance in economic relations also lead to tensions. The era of free-market globalisation results in a state where the US, the UK and various other western countries have large external debts, while China, other eastern countries, and to some extent Russia are in an external credit position.
New age defence stocks
In this modern era, when physical battles are being fought, it is safe to say that at the same time, there is cyber warfare. Cyber warfare is the use of cyber attacks against an enemy state, causing comparable harm to actual warfare and/or disrupting vital computer systems. Some intended outcomes could be espionage, sabotage, propaganda, manipulation or economic warfare
Several hacker groups have joined in on the Israel-Hamas conflict escalation that started over the weekend after the Palestinian militant group launched a major attack.
Many Israeli websites and infrastructure have been targeted by hacker in an attempt to compromised Israel’s networks and shut down Israeli government websites. Hackers also targeted the Israel Electric Corporation, the largest supplier of electrical power in Israel and the Palestinian territories, as well as a power plant.
Cybersecurity stocks also performed strongly, with Palantir Technologies (NYSE: PLTR) climbing 4% and Okta (NASDAQ: OKTA) adding more than 4%. However, cybersecurity stocks with a higher proportion of Israel assets or manpower performed poorly as there were concerns on either operational performances as well as stability of their assets.
All things eventually come to an end
Wars, conflicts and threats all lead to increase defence spending as governments either go on an offensive or bulk up their spend to shore up their defence. At the onset, this has historically lead to the outperformance for defence company stocks.
Fortunately, all wars eventually come to an end of some sort as objectives are achieved. As defence spending reduces or spending priority changes, defence stocks are expected to do no better than the overall market.
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