U.S. defense stocks "stalled"! Bernstein: Short-term catalysts are quickly "depleted", unlikely to improve before midterm elections.

The conflict within the Middle East GEO Group Inc continues to escalate, but the US defense sector did not strengthen as some investors had expected. On the contrary, since the outbreak of the Iran war, the stock prices of major defense contractors have generally fallen by 13% to 26%. Bernstein analysts pointed out that the short-term catalysts driving the rise in defense stocks are fading, and the sector lacks the momentum to attract funds before the midterm elections in November. Since the outbreak of the Iran war, there was a widespread expectation in the market that the tense situation in GEO Group Inc would directly benefit US defense stocks. However, the actual trend has been the opposite of expectations. As of early June, Lockheed Martin (LMT.US) has fallen by about 13%, Northrop Grumman (NOC.US) has dropped by over 20%, Raytheon Technologies (RTX.US) has also recorded a double-digit decline, with a total decline of around 26%. Despite discussions in the US Congress about increasing military spending and the Trump administration proposing a defense spending plan of up to $1.45 trillion, the defense sector has performed significantly weaker than the overall market. Bernstein: Sector rotation is the main reason, fundamentals have not deteriorated Regarding this unusual trend, Bernstein analyst Douglas Harned stated in a research report released on June 2 that the main reason for the decline in defense stocks is not the deterioration of industry fundamentals, but sector rotation of market funds. "At the beginning of the Iran conflict, the valuations of defense stocks were already near historical highs," Harned wrote, "which made the sector particularly vulnerable when investors turned to high-growth opportunities." He pointed out that as investors turned their focus to sectors such as technology and consumer goods with faster revenue growth, funds were continuously withdrawn from defense stocks. However, he also admitted that the extent of the sell-off exceeded Bernstein's previous expectations. Attractive fundamentals but declining appeal, lack of catalysts before elections "We believe that the fundamentals of the defense industry are still strong," Harned stated, "but at current valuation levels, the appeal of defense stocks has significantly declined for investors looking for higher revenue growth opportunities." Bernstein maintains a "robust" assessment of the industry fundamentals but acknowledges the lack of catalysts strong enough to reignite market enthusiasm in the short term. Analysts expect this situation to remain unchanged before the November midterm elections. Harned bluntly stated, "The biggest issue right now is that we don't see any strong catalysts that can inject new momentum into defense stocks before the elections." Another concern in the market is that if the Democratic Party wins a majority in one or both houses of Congress, they may push for cuts in defense spending. Bernstein offers a different perspective on this. Harned pointed out that historical experience shows that regardless of which party controls Congress in the context of high political threats, the actual impact on military budgets is minimal. "Investors may have overestimated the political risks brought by the elections." Long-term bullish outlook, but revenue conversion is questionable From a longer-term perspective, Bernstein remains positive about the defense sector. Even if Congress eventually shrinks the $1.45 trillion defense plan proposed by Trump, the institution still expects defense spending to further increase from the current levels. However, Bernstein also reminds investors to pay attention to a key issue: how quickly can higher defense budgets revenue growth for contractors? The report pointed out that many contractors in crucial areas such as missile production and shipbuilding are already operating at near full capacity. This means that even if military orders increase rapidly, capacity constraints may limit the speed of revenue realization. In the short term, defense stocks are facing dual pressures of a "catalyst gap" and sector rotation. It may be difficult for the sector to have trend opportunities before the midterm elections. However, from the perspective of fundamentals and the long-term trend of defense spending, Bernstein has not turned pessimistic. What investors need to weigh now is the time difference between valuation digestion and capacity bottlenecks, as well as the clarification of policy paths after the elections.