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Investors Have a Defense Stock Hangover, but the Spending Party Hasn't Even Started

We think the midterm elections could provide an investment opportunity as uncertainty rises beforehand.

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We think the U.S. midterm elections slated for Nov. 6 could provide investors with an entry point to high-quality, moaty defense companies. However, even if the Democrats win back the House of Representatives (possible) and the Senate (less likely), the increases in the fiscal 2019 defense budget are close to being locked in, and we also don’t expect large decreases in U.S. defense funding for fiscal 2020 or 2021. Provided a Republican occupies the White House, we think the House and Senate budget hawks will probably go along with any spending plans passed in their respective chambers if the Department of Defense receives budget increases equal to nondefense agencies. That said, we do expect more volatility in the defense names we cover as we approach the midterms and potentially following the election as well.

A Democratic speaker wielding the gavel in the House remains a more distinct possibility than the Democrats flipping the Senate, in our view. The Democrats need to win 23 seats to take back the House. The Cook Political Report believes 19 Republican seats in the House are vulnerable going into the midterms, which means the Democrats would need to win these Republican seats and pick up four additional seats in districts that have been leaning slightly Republican. Although we don’t think it’s likely, should a Democratic sweep of the House and the Senate suddenly become more probable, then we expect defense share prices to fall on the back of investor uncertainty stemming from the possibility of a divided government.

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Chris Higgins does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.