Defense Stocks Fall Out Of Favor. Polymarket Might Have The Answer As To Why
The S&P Aerospace & Defense Select Industry Index is little changed year to date, despite conflicts across Eurasia and expectations that a coming rearmament cycle will substantially boost missile and bomb production. The muted performance highlights a disconnect between investor appetite and the Trump administration's anticipated expansion of defense production.
Allyson Gordon, UBS head of Americas sector specialists, explained in a note to clients on Thursday that US aerospace and defense stocks were being weighed down by elevated bond yields and weakness in individual names.
ATI, Carpenter Technology, RTX and Lockheed Martin were among the names drawing attention, Gordon said. She said her trading desk attributed much of the weakness to broader sentiment and investor fatigue with the aerospace trade, rather than a clear deterioration in operating conditions.
"Some investors have pointed to Wednesday's weakness in Boeing as a possible contributor to today's pressure on original equipment names, although the desk has not heard anything from recent management meetings that would explain the magnitude of the move. In fact, recent feedback has generally been more constructive. On the aftermarket side, GE was said to have delivered a confident message on demand trends, with no signs of weakness emerging in 2026 or 2027," the analyst said.
She continued:
Defense shares also struggled, with LMT coming under pressure during management commentary on margins. However, the reaction appeared larger than any incremental change in the company's message versus Q2. More broadly, the sector has fallen back out of favor following the post-Q2 earnings squeeze, and investors remain reluctant to add exposure despite increasingly reasonable valuations. Feedback around Gavin's recent LMT upgrade has largely centered on a wait-and-see approach, with many investors preferring to stay on the sidelines until after the midterms.
The desk continues to field questions about whether defense could serve as a relative refuge amid broader market volatility. While that argument reflects a market increasingly driven by a process of elimination, investor interest has recently gravitated more toward select government IT names, where positive reactions to Q2 results have shown greater staying power.
A chart comparing the inverse 30-year Treasury yield with the UBS Aerospace basket highlights how a wide divergence that emerged earlier this summer has now largely closed, underscoring the extent to which aerospace equities have repriced alongside the rates backdrop.
The broader problem for defense bulls is a lack of willing buyers. Following a rally after second-quarter earnings, the sector has slipped out of favor again. Why is that?
One possible explanation is investor concern that a change in Senate control could complicate negotiations over the timing, size, and composition of defense funding. Congress determines appropriations, making congressional negotiations key to the funding process.
Our chart compares Polymarket pricing on Senate control after the midterms with the S&P Aerospace & Defense Select Industry Index, with one series inverted. The comparison may suggest why investors are exiting the trade.
Beyond the repricing of defense stocks due to rising bond yields that Gordon described, uncertainty surrounding post-election defense funding negotiations offers another reasonable explanation for investor caution.