A large ship is under construction at General Dynamics in San Diego, Calif., last month.Mike Blake/Reuters
U.S. defence stocks have declined even as the Iran war drags on, indicating that the typical “buy-on-conflict” trade had largely peaked in the weeks before in anticipation of tougher action by President Donald Trump.
The NYSE Arca Defense index, which includes 34 small- and large-cap U.S. companies, fell nearly 8 per cent in March, compared with the broader S&P 500’s 5-per-cent drop. In contrast, it had gained about 12 per cent in February, 2022, when Russia invaded Ukraine.
The sluggish performance, strategists said, signalled investors were unwinding positions after a strong run this year and does not reflect fading demand or doubts about longer-term defence spending.
“A lot of conflict premium was in their valuations,” said David Bianco, Americas chief investment officer at German asset manager DWS.
“We saw gold and oil and defence rally, part of the reason was messages from the administration, when Trump was sending the armada to the Middle East. Nobody knew anything, but they saw chances of a conflict.”
Mr. Bianco said he began reducing his “overweight” position on defence stocks before the Middle East conflict began.
Trump delivers contradictory messages on Iran war in White House address
There were signs well before the U.S.-Israeli bombing began in late February that Washington was preparing for a confrontation with Tehran.
Reuters reported in the weeks leading up to the war that the U.S. was building up forces in the Middle East and preparing for a weeks-long operation if diplomacy failed.
Similarly, the European defence sector fell 11 per cent in March, marking its biggest monthly loss since the pandemic amid a broad selloff on worries of a potential energy shock owing to the war.
Defence shares had rallied for weeks as European governments announced sweeping rearmament plans after Russia’s invasion of Ukraine.
Earlier this year, Mr. Trump proposed a US$1.5-trillion U.S. military budget for 2027, well above the US$901-billion approved for 2026, but uncertainty remains over whether Congress will pass such an increase.
“Nothing that has happened so far suggests that a $1.5 trillion 2027 defence budget could be exceeded. For these reasons, one should not expect upside to come from the current conflict,” Bernstein analyst Douglas Harned said in a recent note.
The defence index has surged more than 150 per cent between 2020 and 2025, leaving the sector at historically elevated valuations.
The S&P 500 Aerospace & Defense sub-index trades at about 32 times 12-month forward earnings, well above the broader S&P 500’s multiple of roughly 20 times, according to LSEG data.
Earnings expectations muted despite war
Market reaction has also been subdued to the Pentagon’s attempts to boost production to replenish depleted missile and ammunition stockpiles.
Any revenue gains will take time to materialize as long production cycles and capacity constraints limit how quickly output can ramp up, analysts say.
Expectations for 2026 earnings growth hovered around 12 per cent at the end of March versus about 15 per cent at the start of 2026 for General Dynamics Corp. GD-N, Lockheed Martin Corp. LMT-N, Northrop Grumman Corp. NOC-N, L3Harris Technologies Inc. LHX-N and RTX Corp. RTX-N, according to Tajinder Dhillon, head of earnings and equity research at LSEG Data & Analytics.
“The conflict would need to last longer, or expand materially, for [earnings] estimates to move higher,” said Sameer Samana, head of global equities at Wells Fargo Investment Institute.
Supply constraints, policy pressure
Beyond valuations, investors pointed to limited production flexibility.
Richard Safran, senior analyst and managing director of aerospace and defence at Seaport Research Partners, said funding of defence firms gets diverted to immediate operational needs rather than modernization or development needs during conflicts.
The Trump administration is also pressuring defence firms to prioritize production over shareholder payouts, exacerbating uncertainty around capital returns.
The sector’s medium-term outlook depends heavily on U.S. budget decisions, with key spending details expected on April 21, Bloomberg News reported.