U.S. Defense Stocks Underperform the Broader Market YTD as Midterm Election Risks Weigh on Valuations
nashnova research
U.S. defense stocks have fallen 13% since late February while the S&P 500 gained nearly 10% — a gap exceeding 20 percentage points; a Democratic-leaning midterm outlook and valuations at 30-year highs are squeezing the sector short-term.
How bad is the sell-off?
The S&P Composite 1500 Aerospace & Defense Index has dropped 13% since February 27. Over the same period the S&P 500 rose nearly 10% — an underperformance gap of more than 20 percentage points.
The iShares U.S. Aerospace & Defense ETF is on track for two consecutive quarters of net outflows, the first time that has happened since 2023.
This means → it is not just prices falling — capital is actively leaving the sector, not merely repricing.
Which companies have been hit hardest?
The three deepest decliners: missile supplier Karman Holdings, defense-tech firm Kratos Defense, and drone maker AeroVironment — each down at least 38% since late February.
Legacy prime contractors have not been spared either: Northrop Grumman, Lockheed Martin, Huntington Ingalls, and L3Harris are all down at least 18%.
In plain terms = whether "new-wave" or "old-guard," the entire defense sector is selling off — the only question is by how much.
Why are midterm elections the key variable?
The Trump administration requested a $1.5 trillion defense budget for FY2027 — $1.15 trillion in discretionary funds plus $350 billion via budget reconciliation — fueling expectations of large contractor orders.
But a September 14 poll showed 44% of respondents favoring Democratic congressional candidates versus 37% for Republicans — a 7-point gap, the widest since January 2025. Prediction markets also point to a higher probability of Democrats winning the House.
This means → if Democrats take the House and create a "split Congress," that $1.5 trillion budget is far more likely to be scrutinized line by line and trimmed, rather than passed as a package.
Just how expensive is the sector?
The defense index trades at a forward P/E of 27×, well above its 30-year average of roughly 18× and above the S&P 500's current 19×.
Apollon Wealth Management CIO Eric Sterner said: "Simply because the P/E is elevated relative to the past 30 years, we could see further pressure on the sector."
In plain terms = even without election risk, the valuation alone — 50% above its own 30-year mean and 40% above the broader market — is enough to give capital pause.
Has the long-term thesis changed?
Analysts broadly view the long-term outlook as still strong. Arax CIO Don Hagan noted: "The strategic necessity of military modernization transcends most political positions."
Ongoing global geopolitical tensions and Europe's push to raise defense spending are also seen as long-term tailwinds for contractors.
But Guggenheim analyst Michael Ciarmoli pointed out that the market is pricing in a worst-case "blue wave" scenario — a sweeping Democratic victory.
What are the next dates to watch?
December 11: the FY2027 continuing resolution expires — this falls squarely in the post-midterm "lame duck" session (the transition period between the election and the new Congress taking office), making it a critical window for budget negotiations.
The November 3 vote and the resulting congressional control map will determine whether the defense sector can regain investor favor.
This reflects a market that is not rejecting the industry's fundamentals but rather repricing for a window of peak political uncertainty.
市场有风险，内容仅供研究参考，不构成投资建议。