One unusual development in the current market is the underperformance of defense stocks. From the March bottom, the Dow Jones U.S. Aerospace & Defense Index is 50% higher, and it's 28% off its pre-coronavirus high.
This index can be tracked with the SPDR S&P Aerospace & Defense ETF
In the U.S. and globally, defense spending has continued to rise nearly every year, since the statistics started to be tabulated. And, the growth rate is higher than overall GDP growth rates. This makes the industry attractive in a recessionary environment. Further, while business and consumer spending fluctuate with the economy, government spending is much less volatile. Due to these factors when the economy starts to slow down, investors tend to pile into defensive stocks.
Another reason is that these companies have strong balance sheets and payout above-average dividends. Additionally, their dividends become more valuable as interest rates decline, which they tend to do during these conditions.
A couple of Theories
So, it's certainly mysterious why defense stocks are underperforming the broader market given the current recession and record-low interest rates. While the 10-year Treasury is yielding 0.6%, companies like Lockheed-Martin
One potential factor may be the increasing chances that Democrats will take over the executive and legislative branches. Joe Biden has said he is going to crack down on weapons sales to certain countries. Additionally, Democrats tend to prioritize other types of spending over defense spending. However, it's worth noting that defense spending has historically increased under Democratic administrations just at a slower rate.
Another possibility is that during the last leg higher of this bull market from February 2016 to February 2020, defense stocks outperformed by a significant degree, especially relative to their size and defensive nature. Lockheed Martin was 120% higher, and Raytheon was 90% higher. Most defense stocks outperformed the S&P 500. That outperformance was just as unusual as today's outperformance given that from February 2016 to October 2018, growth and interest rates were moving higher.
Finally, defense stocks' relative weakness may be reflecting that globally, governments may prioritize healthcare and economic spending over defense spending given the effects of the coronavirus. It's also revealed gaps and weaknesses in countries' "healthcare infrastructure" that needs addressing. The economic devastation is probably going to require higher levels of support for schools, state, and local governments who will see their tax revenues plummet due to the devastation of small businesses. The weakness in defense stocks may also reflect this shift in national priorities.