Defense stocks to take off ahead of 2020 election

Defense stocks typically outperform in election years

Defense stocks are off to a red-hot start for 2020 amid an escalation of geopolitical tensions in the Middle East and could get even hotter as the 2020 election approaches.

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The sector has gained 6 percent since Iran’s Dec. 31 attack on the U.S. embassy in Baghdad. The U.S. responded by killing Iranian Gen. Qassem Soleimani in an airstrike, prompting Tehran to retaliate with a missile attack.

The recent events “add to the case for the benefit of ‘portfolio insurance’ from defense stocks,” wrote UBS analyst Myles Walton in a note to clients Tuesday. He noted that defense stocks typically outperform on the day of such an event before seeing a lessening impact over time.

However, the sector has an even bigger tailwind at its back.

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Defense stocks have outperformed in nine of the last 10 election cycles, by an average of 1,600 basis points (16 percent), according to Walton.

“We see this as a positive for the defense space for this year and, should geopolitical events take less of a hold on defense sentiment, we still see upward potential supported by historic trading trends,” he wrote.

SunTrust analyst Michael Ciarmoli agrees that 2020 is shaping up to be a strong year for defense names. He thinks the sector can outperform despite posting a 46 percent return last year, outpacing the S&P 500’s 28.9 percent gain.

“A flattening U.S. Defense budget coupled with the curtailment of legacy programs may create headwinds but given still elevated threat environments (i.e. Iran, North Korea, etc.) along with the ongoing arms race with China and Russia we see a compelling demand backdrop,” Ciarmoli wrote in a note sent to clients on Tuesday.

His favorite idea for 2020 is the military-communications technology provider L3Harris Technologies, which is “ideally situated to outgrow the broader defense budget.” Ciramoli has a “buy” rating and $261 price target – 22.7 percent above where shares settled Tuesday.

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Walton’s top defense picks are the F-35 maker Lockheed Martin and the shipbuilder Huntington Ingalls Industries.