Defense Stocks Are Hot, But Think Twice Before Investing

I came across several news stories this week about global defense expenditures rising from $1.55 Trillion in 2015 to $1.57 Trillion this year, a substantial rise that reflects various geopolitical risks and uncertainties.
Immediately after reading a few of these stories, I looked at the charts for several defense stocks.
As I assumed they would be, all were on the rise. They had all been climbing for months.
When I sat down to write this article, I checked them again. And again as I suspected, prices had started to fall. Just days later.
Let’s take a look at Boeing (NYSE: BA):
When I checked Boeing’s chart on Tuesday, it was gaining, rising as high as $160.07.
When I checked Boeing’s chart today, Thursday, it had fallen, closing at $153.77.
This phenomenon—a stock rising for months in anticipation of an event then peaking on a news report and falling shortly after—is a perfect example of the old adage:

Buy the rumor, sell the news.

What this means is that, as a rumor starts to spread of an event or announcement, whether through media or insider gossip, traders buy the rumor as though the event or announcement has already happened. In other words, they build the event into the price of the stock in anticipation of an event leading to a rising stock price.
When the event or announcement happens, the trading catalyst is in the past and the traders who drove the price higher in anticipation sell their positions and the stock falls.
Traders familiar with this pattern can make huge gains anticipating this type of trend, but that’s easier said than done.
The reason is that once the event or announcement takes place, less-experienced traders are temped to hold onto to the stock because the event added value to the company, forgetting that it was already priced into the stock well before the event ever happened, then finding themselves in a losing position.
But if you recognize the pattern and pay attention to the rumors, and can put aside your emotions to avoid the mistake of holding on too long, you can do quite well.
In our example with defense stocks, rumors about increased global expenditures began circulating in April of this year.
If we take Boeing again as our example, its stock price closed at $126.96 on April 1. If you had invested then and sold at the top on Tuesday at $160.07, you would have made 26% on your investment, catching the upside of the anticipatory trend and truly buying the rumor and selling the news.
But since we’re now past the catalyst—the announcement that global defense expenditures have risen—what is there to do?
Considering the geopolitical risks that pushed defense spending higher are still present—and that the U.S. has just elected Donald Trump, who has promised to increase military spending in the nation with the highest military expenditures by far—it wouldn’t be surprising if defense stocks continue to rise.
If we compare a handful of defense stocks, we can see that they have all been on a pretty steady climb since 2009.
Realistically, most of these stocks are overvalued. Instead of buying defense stocks now after the news that military spending is increasing world-wide, wait for a correction and better valuations.
It’s clear that after the Tuesday high this week that these stocks have started to come down, and this may be the beginning of a correction that would make defense stocks more attractive.
I’ll be keeping an eye on General Dynamics (NYSE: GD). General Dynamics has a healthy dividend, and isn’t as overvalued as some other defense stocks.
Defense revenue accounts for roughly 60% of GD’s total revenue, and the company is also exposed to the steadily growing market for private jets.
Considering its lower valuation relative to its peers, and that the company is exposed to a potential continuation of the ramp-up in military spending, I think it’s likely that the stock will outperform.
General Dynamics also boasts a strong balance sheet and has widened its operating profit margin since 2013, a trend I expect will continue on in the next several years.
Keep an eye on defense stocks and wait for a correction as it will make for a great buying opportunity in a sector that is sure to continue its climb.
As for that old adage, pay attention and watch for rumors. If you read something enticing, do some research to verify the beginning of a trend and get in on it early. And don’t forget to ditch your emotions and sell when the news finally breaks.