Trump, Kim handshake, talk of peace sinks U.S. defense stocks

Adam Shell | USA TODAY

Show Caption Hide Caption Donald Trump defends historic meeting with Kim Jong Un During a marathon press conference, the President said he invited Kim Jong Un to the White House, and that the North Korean dictator accepted.

Talk of peace between the U.S. and nuclear-armed North Korea sank defense stocks Tuesday.

While the broad U.S. stock market reaction to the historic agreement between President Trump and North Korean leader Kim Jong Un to establish a new relationship committed to "peace and prosperity" was muted, shares of defense contractors took a dive.

Shares of Raytheon, which makes Patriot and Tomahawk missiles, closed 2.8% lower. Lockheed Martin, which supplies the Pentagon with air and missile defense systems as well as the F-35 Stealth fighter jet, tumbled 1.3%. And Northrop Grumman, which has increased its focus on cyber warfare and missile defense systems more recently, declined 1.5%. Boeing, which makes Apache helicopters and aerial refueling aircraft, dipped 0.1%. General Dynamics, a Navy shipbuilder, fell 1.6%.

By contrast, the Dow Jones industrial average finished the day virtually unchanged with a loss of less than 2 points.

Any political or diplomatic developments that lower the chance of military conflict cools investors interest in defense-focused companies, says Brad McMillan, chief investment officer for Commonwealth Financial Network in Waltham, MA

"If weapons are used they need to be replaced," says McMillan. "That makes war a growth story for these stocks, and one of the big potential growth stories recently has been North Korea," he continued, adding, "What the agreement does, at least for a while, is take military conflict off the table."

While peace overtures between the long-time enemies will put "defense stocks on the defensive" in the short term, investors shouldn't worry about long-term problems for makers of military equipment, explains Gary Kaltbaum, president of Katlbaum Capital Management.

"Funding," he says, will be "plentiful for years to come."

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President Trump signed a $1.3 trillion spending bill in March that includes a $160 billion boost in defense spending over two years, "reversing years of decline and unpredictable funding," according to the U.S. Department of Defense.

And thawing relations between the U.S. and North Korea isn't likely to translate into lower defense budgets, Bloomberg Intelligence aerospace analyst George Ferguson noted recently. He expects U.S. military expenditures to continue to rise.

"If North Korea turns from a pariah state to being welcomed in the world community," Ferguson wrote in a recent report, "there are still enough trouble spots that require strong defense spending, supporting revenue and profit growth at prime defense contractors."

U.S.-based defense companies get a large portion of their sales from the Pentagon and U.S. government. Both Raytheon and Lockheed Martin, for example, get 70% of their sales from the U.S., according to Bloomberg.

That's likely why the handshake between Trump and Kim that made global headlines, and North Korea reaffirming its plans to work towards "complete denuclearization" of the Korean Peninsula, has not been a bullish development for defense stocks,