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Three Must-Own Defense Stocks

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It could prove profitable to allocate a fair share of capital to U.S. defense stocks, in light of current geopolitical conflicts. The threat of military action in Asia and the Middle East ensures a sympathetic Congress and sizable budget increases in coming years while industry consolidation could increase profits in the sector’s already narrow leadership. Better yet, many components remain undervalued, trading well below 2015 bull market highs.

This week’s regulatory news highlights the growing opportunity, with the European Union (EU) finally clearing Rockwell Collins, Inc.’s (COL) $6.4-billion takeover of B/E Aerospace, Inc. (BEAV). It’s a marriage made in heaven because their synergies in high-tech cabin interiors and avionics will provide key competitive advantages that should attract lucrative military contracts as the U.S. armed forces develop new engagement strategies in the Trump administration.

Rockwell Collins topped out at $76 in October 2007, following a long uptrend, and sold off to $27.67 during the 2008 economic collapse. A recovery wave into 2010 came up short, stalling 8-points below the prior high. It took another three years to complete the round trip, yielding a 2014 breakout that ended at $100 a year later, ahead of a rounded correction that tested new support three times into November 2016. The stock took off with the broad market after the election, finally reaching resistance at the 2015 high last month.

Look for a positive reaction to the EU news, with decent odds for a major breakout into triple digits, followed by a buying surge toward $120. Additional consolidation in and around the $100 level is also possible, offering an alternative buying strategy that allows market players to build long positions at a slower pace. This less volatile path makes more sense, given the deteriorating technical outlook in the broader market.

Lockheed-Martin, Corp. (LMT) made unwelcome headlines after the November election, with the president-elect tweeting about cost overruns in the F-35 fighter jet contract. However, the new administration needs the industry’s biggest players to modernize the U.S. military and is likely to back off from criticism in coming months. Investors and market timers have already taken heed, lifting the $78-billion company to an all-time high above $270.

It’s unlikely to be a smooth rise if past is prolog because the rally has reached rising wedge resistance that could trigger a quick slide toward 260. Also, On Balance Volume (OBV) is stuck well below the August 2016 peak, with sidelined capital hesitant to buy and get caught in another Trump tweet-storm. This hesitation looks misplaced, given recent Middle Eastern and Asian headlines.

United Technologies, Corp. (UTX) also got targeted in the post-election maelstrom, with job decisions at the Carrier division attracting the president-elect’s wrath. Fortunately, hat storm has passed, allowing shareholders to get back in the business of building profits. It looks like a fresh buying opportunity is setting up, with the stock running into selling pressure above $113 since early January.

Like Lockheed-Martin, this issue has ground out a broad rising wedge pattern, with current resistance centered near $115. It’s vulnerable to a steeper pullback than its rival, with two 2017 declines into $107 finding substantial buying interest. A third trip should also be buyable but healthy accumulation could keep the price above $110, ahead of an intermediate breakout that opens the door to a critical test at the 2015 bull market high near $125.

The Bottom Line

Defensive stocks offer a logical way to play growing geopolitical risk, with U.S. military budgets likely to rise sharply in coming years. Market players have been unusually slow in recognizing this developing opportunity, instead focusing on traditional safe havens including precious metals and U.S. Treasuries. That’s likely to change as confrontation and casualties bring home the reality of a more dangerous America.

<Disclosure: the author held a long position in Lockheed-Martin at the time of publication.>

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