The stock market and oil prices were rattled late in the week after
violence in the nation escalated as a Sunni insurgency against the
government heats up. A continued escalation of the conflict could
result in a civil war and a possible break-up of the country.
Even with tensions in the region mounting, the PHLX defense sector
<.DFX> was down about 1 percent for the week, retreating with the
broader S&P 500 <.SPX> after both indexes had closed at record highs
on Monday. Some caution in the market would be expected, but higher
oil prices and concerns about a worsening of the conflict would be
felt in defense and energy areas.
"As investors try to determine what stocks and which sectors would
benefit if we continue to see troubles in Iraq, itís logical that
more defensive sectors would benefit and especially the defense
stocks themselves," said Kate Warne, investment strategist at Edward
Jones in St. Louis.
"As investors get more nervous about the situation in Iraq, it will
be a typical situation where itís positive for the stocks like oil
... and we will see more caution across the board in other stocks."
Escalation doesn't necessarily mean investors will flock to defense
stocks solely on expectations they will see a revenue boost as a
result of an increase in new government contracts.
Americans are wary of getting re-involved in the fighting in Iraq
given forces are still in country after the U.S. invasion in 2003
that has since cost the lives of more than 100,000 civilians and
several thousand soldiers.
Scott Armiger, portfolio manager at Christiana Trust in Greenville,
Delaware has owned Northrop Grumman Corp <NOC.N> since August, but
said, "We are not going to boost defense stocks holdings on this
move in Iraq, especially with this administration. I surely donít
think itís a build-up, it conflicts with other agenda items,
domestic is still number one."
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The defense index has gained 93 percent in the last three years. It
has a 50-day correlation with the benchmark S&P index of 0.89, but
that may begin to break down should violence in the region grow,
putting stocks in the defense sector in position to move higher
while the broader market retreats.
The United States does appear to be acting in a deliberate fashion
for the time being. After threatening military strikes against
militants from the radical Islamic State of Iraq and the Levant
(ISIL) on Thursday, President Barack Obama said on Friday he will
take several days to review options for how the United States can
help Iraq deal with the insurgency.
Another consideration for defense stocks is they generally have
other businesses to go along with revenue generated from defense
contracts - Boeing <BA.N> is involved with commercial airplanes and
Precision Castparts <PCP.N> also deals with medical implants - so
while they may get a lift a growing conflict it will not be the sole
factor for any price boost.
"Many of the defense stocks trade with the expectations that we will
see cutbacks in government spending in areas like defense but the
stocks are really reflecting better performance on other parts of
the business," said Warne. "Any company that relies solely on
defense right now is probably not in great shape."
(Reporting by Chuck Mikolajczak; Editing by Nick Zieminski)
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