President Trump’s decision to kill Qasseem Soleimani, the leader of Iran’s Quds force, led to ramifications on Wall Street including strength in defense stocks and oil. Equity markets were mostly lower although stocks finished off lows.
The aerospace and defense sector was up nearly 30% in 2019, underperforming the S&P 500 by a slight margin. Most of the weakness was due to Boeing’s (NYSE: BA) issues with the 737Max. Absent Boeing, the sector outperformed by a significant degree. Two of the catalysts in addition to the stock market’s upward trajectory was the larger-than-expected defense bill approved with bipartisan support and the steady decline in interest rates.
Increasing Tensions
The strike was in retaliation to Iran’s increased aggression in the Middle East such as the recent strike on Saudi Aramco’s refining facilities and an attack on the US embassy in Baghdad. Iran’s actions were in response to President Trump walking away from the nuclear deal and placing even more stringent sanctions on the country which is doing considerable economic damage, increasing support for reformists, and undermining the ruling regime.
While complications and tensions in that part of the world are a certainty, the US taking out the second most powerful person in Iran is a clear escalation. Many foreign policy experts are expecting some sort of retaliation from Iran. Although a full-blown war remains unlikely, the odds of it happening have risen.
Defense Stocks Primed to Outperform
2020 looks to be another promising year for the sector, and it should outperform the broader market given this recent positive catalyst, trends in global defense spending, and the Fed’s dovish tilt. Although the sector had a splendid 2019, it stagnated in the latter months as investors moved to faster-growing areas like emerging markets and small-caps.
Interest rates also were strong during this period, creating a headwind for the sector. The defense and aerospace sector is filled with huge companies with large balance sheets that thrive in falling rate environments. Lower interest rates mean that these companies can borrow for cheaper, and it makes their dividend yields more attractive to investors.
Based on recent comments by Fed Chair Jerome Powell, it’s fair to assume that interest rates are going to stay low for an extended period. He raised the threshold to raise rates by stating that inflation needed to be “persistently” above the target rate before another hike was warranted. Based on this logic, rates would never have been hiked in 2017.
Another factor to expect rates to stay depressed in 2020 is the looming election. The Fed is determined to stay out of partisan politics and retain its institutional credibility. Therefore, it’s not likely to step into the middle of a contentious election by raising rates. This would also mark the Fed’s second U-turn on monetary policy in less than two years.
Global defense spending continues to set records with total expenditures expected to exceed $2 trillion in 2020 with the US contributing $715 billion. This spending comprises a significant portion of revenue for these stocks. Of course, trends in defense spending will only accelerate with a full-fledged war with Iran.
Promising Setups
Overall, the sector looks poised to breakout following an almost six-month consolidation due to supportive trends, strong fundamentals, and this explosive catalyst. In 2003 when the war with Iran began, many defense stocks gained between 200 and 300% in the ensuing years. Those types of gains are unlikely to be replicated as that period also coincided with the end of a bear market.
However, the sector is offering plenty of low-risk opportunities with significant upside. For example, General Dynamics’ (NYSE: GD) weekly, the three-year chart shows the stock has built a base for the past few months with a price target of $200 and a stop-loss at the October lows around $172.
The aerospace & Defense ETF (NYSE: XAR) shows that the sector’s breakout is just starting. More aggressive, short-term oriented traders can consider buying into this breakout with a tight stop-loss around $112. The XAR chart suggests a “cup and handle” pattern due to the double top and shallow retracement and is considered a continuation pattern in bull markets.
XAR 1 Day Moving Averages
Name Value Action
Exponential Moving Average (5) 111.40 Buy
Simple Moving Average (5) 110.69 Buy
Exponential Moving Average (10) 110.67 Buy
Simple Moving Average (10) 110.22 Buy
Exponential Moving Average (20) 110.26 Buy
Simple Moving Average (20) 110.08 Buy
Exponential Moving Average (30) 109.98 Buy
Simple Moving Average (30) 110.24 Buy
Exponential Moving Average (50) 109.37 Buy
Simple Moving Average (50) 109.41 Buy
Exponential Moving Average (100) 107.62 Buy
Simple Moving Average (100) 107.93 Buy
Exponential Moving Average (200) 103.94 Buy
Simple Moving Average (200) 103.61 Buy
Ichimoku Cloud Base Line (9, 26, 52, 26) 110.84 Neutral
Volume Weighted Moving Average (20) 110.31 Buy
Hull Moving Average (9) 111.51 Buy
XAR Pivots
Pivot Classic Fibonacci Camarilla Woodie DM
S3 102.64 106.02 108.18 104.69 —
S2 106.02 107.31 108.49 106.27 —
S1 107.56 108.10 108.80 108.06 106.79
P 109.39 109.39 109.39 109.64 109.00
R1 110.94 110.68 109.42 111.44 110.17
R2 112.77 111.48 109.73 113.02 —
R3 116.14 112.77 110.04 114.81 —
