"Blue Wave" risks loom combined with elevated valuations! US defense stocks under collective pressure year-to-date, sharp volatility feared ahead of midterm elections.

Title context: "Blue Wave" risks loom combined with elevated valuations! US defense stocks under collective pressure year-to-date, sharp volatility feared ahead of midterm elections. Text: After two years of unstoppable gains, US defense stocks have hit a bottleneck this year. Since the start of the year, manufacturers of everything from tanks, fighter jets and naval vessels to missiles, drones and other defense technologies have seen their shares significantly underperform the broader market. The S&P Composite 1500 Aerospace & Defense Index, a gauge of the sector's stock performance, has fallen 13% since February 27 (on the eve of the US-Israel-Iran conflict). Over the same period, the S&P 500 has risen nearly 10%. The fund tracking the sectorthe iShares American Airlines Group Inc. Aerospace & Defense ETFis now expected to post net outflows for a second consecutive quarter, which would be the first time since 2023. Aerospace & Defense ETF Faces Outflows Specifically, the biggest decliners in the US defense sector include space and missile systems supplier Karman Holdings (KRMN.US), defense technology company Kratos Defense & Security Solutions, Inc. (KTOS.US) and drone manufacturer AeroVironment (AVAV.US). These companies' shares have all fallen at least 38% since late February. Traditional large defense contractors Northrop Grumman Corp. (NOC.US), Lockheed Martin Corporation (LMT.US), Huntington Ingalls Industries (HII.US) and L3Harris Technologies (LHX.US) have also each fallen at least 18%. Previously, US President Trump's pledge to sharply increase the defense budget had ignited investor expectations that defense contractors would win massive orders and driven defense stocks to record gains. The Trump administration has proposed a $1.5 trillion defense budget request for fiscal year 2027, including $1.15 trillion in discretionary funding and $350 billion secured through the budget reconciliation processa fast-track procedure Congress can use to provide mandatory defense funding. But now, with Trump and his Republican Party facing a worrying midterm election outlook, the market is currently anxious about Trump's ambitious budget plan for the Pentagon. A poll released on September 14 showed that the US Republican Party trails the Democratic Party by 7 percentage points, painting a grim picture for the midterms. The poll, conducted over four days, involved 1,143 US adults. When asked who they would vote for if the US congressional midterm elections were held immediately, 44% of respondents favored Democratic congressional candidates, while 37% favored Republican candidates. The gap was 7 percentage points. This is the largest gap in party support in any result of this poll since January 2025. In addition, polls and prediction markets show that after the November 3 vote, Democrats have a relatively high probability of winning control of the House next year. At the same time, which party controls the Senate is currently closer to a toss-up. As a result, investors are beginning to position for a scenario in which Democrats control one or both chambers of Congress after the midterms. They expect that if Democrats gain control, prolonged negotiations and delays in funding disbursement could intensify further, putting greater pressure on defense stocks. Senate Majority Leader John Thune said he does not expect Republicans to push a budget resolution before the midterm elections. Bloomberg Intelligence analyst Wayne Sanders said: "If Democrats win and Congress is 'divided,' then the process of securing additional defense spending will come under stricter scrutiny, and the necessity of every program will face tougher review. That means ammunition programs are likely to be reviewed item by item, rather than receiving funding uniformly from a larger pool that could cover air defense platforms and other weapons systems." Defense Stock Valuations Far Above Historical Levels Investors are also worried about the high valuations of defense stocks. Data show that the US defense stock index currently has a forward price-to-earnings ratio of 27 times; by comparison, the index's 30-year average is about 18 times. The S&P 500 currently has a price-to-earnings ratio of 19 times. Apollon Wealth Management Chief Investment Officer Eric Sterner said: "Just because the sector's price-to-earnings ratio is at a high level, at least relative to its average over the past 30 years, we may see further pressure on the sector. From now until Election Day, we may see more weakness." Analysts said the stopgap funding plan for fiscal year 2027 will run through December 11. Therefore, the potential "lame-duck" period after the midterm elections could become an important test, one that will show whether investors treat the defense sector's recent weakness as a buying opportunity or as a reason to keep allocating funds elsewhere. In Eric Sterner's view, the current pullback in US defense stocks is "actually a healthy thing." He said: "Typically, before uncertainty appears, the market trades sideways. And once that uncertainty is removed, we may see some of these stocks regain momentum." Analysts and investors said that over the longer term, the outlook for the defense industry remains strong. They noted that although uncertainty over congressional control could affect appropriations, oversight and program priorities, the US government's overall direction of promoting military modernization remains unchanged. Arax Chief Investment Officer Don Hagan said: "There is still a strategic necessity for military modernization, and that truly cuts across most political positions to a large extent." Analysts and investors also noted that escalating geopolitical tensions worldwide, along with pushes in Europe and around the world to increase defense spending, will benefit defense contractors. Osaic Holdings Chief Market Strategist Philip Blancato said: "We are in a situation where, because of the changing nature of the equipment the defense industry is producing and needs, we have no choice but to continue actively increasing defense investment." Even so, even investors bullish on the sector agree that these stocks will still experience sharp volatility in the coming weeks. Guggenheim analyst Michael Ciarmoli said: "Investors appear to be pricing in a 'blue wave' and seem to be assuming the sector will face a worst-case scenario."