Defense stocks have floundered since the Iran war began. Here's why

Defense stocks have lagged despite the U.S.-Iran war, with the iShares U.S. Aerospace & Defense ETF down about 12% since early March and near flat for 2026. RTX fell more than 11% last week and Lockheed Martin dropped more than 13% after earnings/guidance disappointed high expectations. The article highlights concern that 'peak defense' may be in, while political and budget uncertainty around U.S. defense spending adds another headwind.

Analysis

The market is signaling that defense equities were priced for a prolonged, escalation-driven re-rating, while the actual earnings path is reverting to execution and procurement reality. That creates a classic “good geopolitics, bad tape” setup: headline conflict can keep a bid under the group, but the next leg likely depends more on budget cadence, program mix, and margin durability than on war duration alone. In other words, the easy multiple expansion phase may already be behind us unless order flow accelerates enough to offset a slower-than-expected conversion of backlogs into cash.

Second-order, the biggest near-term risk is not demand collapse but timing slippage. If supplemental spending and reconciliation funding get delayed, the sector can face a 6-12 month air pocket where book-to-bill stays supportive yet revenue growth and free cash flow disappoint; that’s exactly the period where investors punish high expectations most. The more nuanced implication is that primes with stronger backlog visibility and less near-term execution risk should outperform, while names with heavier dependence on fixed-price programs or near-dated guidance resets remain vulnerable to further de-rating.

The contrarian take is that “peak defense” may be less about geopolitics and more about positioning. If the market has already de-risked the group, any stabilization in guidance or a cleaner budget process could trigger a sharp relief rally, especially in names that sold off hardest on margin/cash-flow fears. But absent a new catalyst, the path of least resistance is still lower for the expensive, consensus-owned primes because investors are likely to demand proof of conversion, not just evidence of demand.

From a flow perspective, this is also a relative-value story versus broader cyclicals: defense can still work as a low-beta hedge, but it may no longer deserve growth-stock multiples. That argues for owning the most resilient cash-generation profiles and fading the weakest execution stories, rather than making a blanket sector bet.

Key Decisions for Investors

• Reduce outright exposure to RTX and LMT over the next 2-4 weeks; use strength tied to geopolitics to trim. Risk/reward is unfavorable if the group continues to trade on earnings disappointment rather than conflict headlines.
• Pair trade: long NOC / short RTX for 1-3 months. Thesis: favor the cleaner execution and budget-sensitive visibility profile over the name with more apparent near-term margin and guidance risk.
• Buy near-dated downside protection on RTX or LMT into the next earnings window, financed with upside calls if needed. The setup favors a second selloff if management commentary fails to show faster cash-flow conversion.
• If looking to add exposure, rotate toward the strongest backlog/cash conversion names in defense on a 6-12 month horizon rather than chasing the recent laggards. Expected return is better in the “prove it” names than in the most crowded primes.
• Monitor congressional budget headlines as a catalyst trigger; if reconciliation slips materially, consider adding to shorts for a 2-5% further sector derating over the following quarter.