Investors have flocked to U.S. defense stocks amid escalating tensions with North Korea and President Donald Trump’s promises to boost the military, but with towering valuations, their steepest gains may be behind them, APA reports quoting Reuters.
The S&P 500 Aerospace & Defense index .SPLRCAERO has risen 23 percent year-to-date, more than double the S&P 500's .SPX 10 percent increase, and is set for its strongest annual gain since 2013.
Partly due to the situation with North Korea, the index is now valued at about 20.5 times earnings estimates for the next 12 months, its highest since 1999, according to analysts. While defense stocks may continue to spike briefly when rhetoric between Washington and Pyongyang is at its most aggressive, strategists question whether valuations can expand much more.
“To have significant outperformance, it would take large-scale military operations, or a belief the global economy is significantly weakening,” said Jeff Morris, head of U.S. equities at Aberdeen Standard Investments in Boston.
The defense sector’s fortunes may depend more on budgetary matters. If tensions over North Korea stay high, it may be easier for a deeply divided U.S. Congress to pass the 2018 budget, Morris said.
Still, investors should be realistic about spending growth.
“The expectation is that you are going to have a larger increase in the defense budget, but I think some of that is a little too bullish,” said Morningstar analyst Chris Higgins, pointing to fiscal hawks in the Republican Party.
Trump, a Republican, tweeted on Tuesday that he would let Japan and South Korea buy more U.S. military gear, but government approval of weapon sales to foreign countries can take years.
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