Why defense stocks may keep moving higher following initial gains on the Israel-Hamas war

Published Tue, Oct 10 202312:31 PM EDTUpdated Tue, Oct 10 20232:56 PM EDT

Wall Street analysts expect defense stocks will continue to move higher as a result of the outbreak of the Israel-Hamas war making it less likely Congress will delay or curb the nation's defense budget. Defense stocks have underperformed as a group this year amid concerns that partisan divisions in Washington point to lower military spending. For example, the iShares U.S. Aerospace & Defense ETF (ITA) is down more than 6% in the past three months, even after climbing 4.5% Monday in its best day this year. The defense exchange-traded fund gained another 0.7% Tuesday. ITA 5D mountain ITA Many Wall Street analysts now anticipate the conflict along the Gaza-Israel border will support the passage of the Defense Department spending bill for fiscal 2024 by the end of this year. On Monday, the Pentagon said it is working with major U.S. defense contractors to fill Israeli weapon orders. "From the perspective of the DoD budget, the events over the last few days likely provide a smoother path to seeing a 2024 DoD budget done before year-end, and one which either explicitly bypasses spending caps, or provides emergency funding/supplements that indirectly bypass them," Deutsche Bank's Scott Deuschle wrote Tuesday. "This is a clear positive for the entire sector, and meaningfully weakens the bear case on defense, which was heavily contingent on slowing DoD budget growth," Deuschle added. Elsewhere, Citi analyst Jason Gursky said Monday that "the potential for near-peer conflict is likely to accelerate military modernization as the U.S. invests in the tools of deterrence." Some analysts disagree, though they appear to be in the minority. Notably, Bernstein analyst Douglas Harned doesn't expect the Israel-Hamas conflict will change the path of U.S. defense spending. He cited prior conflicts, such as Russia's invasion of Ukraine last year, that didn't end up boosting the defense budget. "The broader focus of the Pentagon and Congress has been on China as a much greater threat, as well as other situations, which include Russia as a global threat (beyond just Ukraine), North Korea, and the Middle East," Harned wrote Tuesday. "One should not expect the Israel situation alone to substantially change that path." LMT 5D mountain Lockheed Martin Regardless, Wall Street broadly anticipates defense stocks could continue rising from current levels. Deutsche Bank expects that Northrop Grumman , which gained 11% Monday, is "arguably one of the largest beneficiaries of an improved ability to get a 2024 DoD budget done." Morgan Stanley has a $532 price target on Lockheed Martin , implying more than 20% upside from Monday's closing price. Deutsche Bank expects increased demand from Israeli Defense Forces could support buying both F-16 and F-35 aircraft. Lockheed shares are down more than 10% this year but gained more than 8% Monday. L3Harris Technologies could see more demand for its ground warfare products including Army radios and night vision goggles, according to Deutsche Bank. It's lower by 14% this year but popped 9% Monday.