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Are Defense Stocks A Buy?

Question posted in the trading room last night which I figured that I'd respond to on the front page for all to see:

Randy when you get the chance some day, can you take a look at the US defense sector please (including stocks like LMT, GD, HON, BA, etc)? I am thinking this sector may be a good buy at some point if we can ever get a decent market correction, given how Trump and both parties seem to want to increase defense spending. Thanks

Actually, I just looked at them after watching the 7 minute condensed version of Trump's speech the other night (on the NRP streaming app... a great resource for those with smart TVs or streaming devices like Roku, Apple TV, Chrome, etc..). Unfortunately, as his campaign vows to boost military spending were just as well know as his pledge to dismantle Dodd-Frank (regulation on the banks), the post-election ramp in the defense stocks nearly mirrors that of the bank stocks.

I've recently shared my views on the banks stocks, with the take that there is a good chance that nearly, if not all, of any benefits of a partial or even full repeal of Dodd-Frank has already been fully priced into the banks & possibly then some (i.e.- at this point they may have overpriced any potential benefits in the foreseeable future & are therefore, likely to correct). After reviewing the charts of the stocks that you mentioned above & many others, I hold the same view with the defense stocks.

This chart of ITA (iShares Dow Jones US Aerospace & Defense Index Fund ETF) clearly illustrates the effect of the Trump Pump, with both a sharp price increase along with massive volume immediately following the election. Also note that although there was a recent surge in volume over the last 3 trading sessions, obviously a result of his speech to congress, with prices initially rallying following the speech: A) they hardly rallied, relatively speaking and B) 100% of that rally was faded yesterday. To me, that reeks of retail (dumb money) buying following the speech & institutional (smart money) selling, as they were able to book some of their profits by selling into that surge of retail buying over the last few days. Just my 2 cent but I think that ship has already sailed, at least for now. My primary scenario for ITA is outlined here, with a potential move down towards the 141 area in the coming months, which could provide an objective long entry on the defense sector. The 131.30 level is my "if things get really ugly" target.

ITA daily March 2rd close

ITA daily March 2rd close

Mar 3, 2017 9:41am|Categories: Equity Market Analysis|Tags: , , , , |4 Comments

4 Comments

  1. Profile gravatar of lee1
    lee1 March 3, 2017 10:35 am at 10:35 am

    Thanks for this, Randy. Good analysis.

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  2. Profile gravatar of lee1
    lee1 March 3, 2017 10:37 am at 10:37 am

    I will revert back to you if we ever get a decent market correction to have you look at the the defense sector again to see if perhaps it looks like a good buy opportunity.

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    • Profile gravatar of rsotc
      rsotc March 3, 2017 12:36 pm at 12:36 pm

      The defense stocks could very well continue to work their way higher, quite likely within that rising wedge or even beyond. However, it appears to me that as the sector had already rallied 30% from the Feb ’16 lows up to the election & then jumped another 18% since then, that most if not all (and then some) of any near-term benefits from increased defense spending has most likely already been priced in. To me, it’s a case of over-valuation, maybe fair valuation at best but at certainly not under-valuation, as I prefer when investing in long-term positions) coupled with what appears to be bearish technical developments that warn of a likely correction. I plotted the trailing P/E ratio of the some of the largest defense stocks (BA, UTX, LMT, GD, RTN, etc.. going back a decade & valuations on all are at or near the high-end of their ranges.

      I’m not short the defense stocks, at least not at this time but I’d rather watch them run another 20% higher without me than go long a sector when I can’t make a compelling case to buy at these levels. That is were I differ from many traders that are momentum traders & might be fine buying the defense stocks here since the trend is clearly bullish at this time. Should the sector pull back to either of my price targets & the charts appear to be firming up at that time, I might look to position long in some individual defense stocks and/or one of the sector ETFs.

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  3. Profile gravatar of Ruben
    Ruben March 3, 2017 2:34 pm at 2:34 pm

    Randy,
    Can you post a chart on BA when you get a chance. I am still short this monster.
    Thank you

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