Federal budget logjam stymies defense stocks, analyst says

Investors are weighing how the outcome of U.S. elections will affect the earnings picture for a variety of industries and stocks. Defense contractors will be constrained in the absence of higher federal spending or a geopolitical crisis that drives demand for weapons, Douglas Harned, analyst at financial-services firm Bernstein, said in a report.

“For defense stocks as a whole, there needs to be a budget breakthrough in a politically frozen Congress,” Harned said in a Sept. 13 report. “While unwanted, major geopolitical crises have typically been catalysts for breakthroughs.”

Congressional priorities are likely to outweigh those of the next president, whether it’s Vice President Kamala Harris or former President Donald Trump. While both candidates are expected to expand the defense budget, there are differences in how they would allocate resources among Europe, the Middle East and Asia.

“Harris continues to stress support for funding Ukraine and allies against Russian aggression, which could drive more spending on tactical weapons and vehicles,” Harned said. “Trump has not expressed support for Ukraine, but has vowed to end the conflict quickly.”

Trump has pushed for more spending on defense projects for outer space and a missile-defense system resembling Israel’s “Iron Dome,” which may not technically feasible. Harris and Trump express support for Israel against Iran and its surrogates, though Trump is more of a hard-liner. Each candidate also is hawkish toward China amid the country’s ambitions to exert greater control over the South China Sea and possibly invade Taiwan.

A Harris presidency may be better for companies that help European countries to expand their tactical weapons, such as General Dynamics (NYSE:GD), Lockheed Martin (NYSE:LMT) and RTX (NYSE:RTX), Harned said.

Trump may be more supportive for space systems at Lockheed (LMT), Northrop Grumman (NYSE:NOC) and L3Harris Technologies (NYSE:LHX), the report said.

Either candidate should be supportive of strategic deterrence, which would be positive for Northrop (NOC) and General Dynamics (GD), and of naval systems, which would benefit General Dynamics (GD) and Huntington Ingalls Industries (NYSE:HII), Harned said.

Debt Ceilings and Budget Deals

Regardless of these different priorities, the next president may face contentious debates in the House of Representatives over the defense budget.

A small but influential group of far-right Republican in May 2023 were successful in placing limits on defense and non-defense budgets as part of a deal on the country’s debt ceiling. The agreement, the Fiscal Responsibility Act of 2023, allowed for a 1% increase in spending for fiscal 2025, followed by inflation-adjusted spending until 2033.

If Republicans maintain their slim control of the House, increases to the defense budget “could be difficult, although a Trump administration could have sway over this,” Harned said.

Conversely, if Democrats gain a slim majority in the House and Harris is in the White House, she may be able to influence any far left, anti-defense House members that seek to exert greater control over spending, Harned said.

“It actually may be the best solution to have either a red wave or blue wave to enable mainstream members of Congress to again control the agenda,” Harned said. “The mainstreams of both parties tend to support more defense spending, as it is also a strong job stimulus with primarily domestic supply chains.”

Global Hot Spots

Geopolitical tensions are an important determinant of defense spending, not the party in control of Congress.

“Historically, the conventional wisdom has been that Republicans are positive for defense spending and defense stocks, while Democrats are negative,” Harned said. “This is not the case. It is external threats that are most important for budgets and the stocks.”

Defense stocks typically outperform when the White House switches parties. The one exception was 2020, when the stock market got a lift after vaccines were shown to be effective against Covid-19, according to Bernstein’s analysis.

“We remain neutral on defense stocks at this time, as we have not yet seen a path to break through the budget logjam,” Harned said.