Defense stocks slip as Iran war fails to spark sector rally
XAR and ITA ETFs fall despite escalation, with LMT, NOC, RTX pressured by stretched valuations and policy uncertainty
Defense sector exchange-traded funds have retreated in recent sessions despite escalating military conflict between Iran and Western forces, confounding historical patterns where geopolitical tension typically boosts defense contractors. The SPDR S&P Aerospace & Defense ETF (XAR) and iShares U.S. Aerospace & Defense ETF (ITA) have each fallen more than 9% since the conflict's onset, according to market analysis from Benzinga. Shares of major prime contractors including Lockheed Martin (LMT), Northrop Grumman (NOC), and RTX Corporation have traded sideways or declined since hostilities began.
The counterintuitive market reaction reflects stretched valuations across the defense sector. Defense stocks have surged approximately 50% since mid-2024, pushing multiples to historical highs that leave limited room for further upside even as military spending commitments accelerate. Lockheed Martin currently trades at a price-to-earnings ratio of 29.86, while RTX commands an even richer multiple of 41.33 times earnings. Northrop Grumman's more modest P/E of 24.93 still represents a premium valuation relative to industrial peers.
"Valuations in the sector are currently near historical highs, diminishing their responsiveness to new geopolitical tensions," according to sector analysis. The research notes that defense stocks had already priced in significant geopolitical risk following months of rising tensions, leaving limited catalyst to drive further gains when actual conflict materialized.
Beyond valuation concerns, the Iran conflict is accelerating a structural shift in defense procurement economics. Expensive traditional missile defense systems are being deployed against low-cost drone threats, highlighting cost inefficiencies in legacy platforms. This dynamic is driving investor interest toward emerging defense technology companies focused on autonomous systems, artificial intelligence, and space-based capabilities. The equal-weighted XAR ETF, which holds more exposure to smaller defense technology firms, has gained nearly 60% over the past year compared to 44% for the market-cap-weighted ITA, reflecting this rotation.
Policy uncertainty adds another layer of complexity for traditional defense contractors. Analysts have flagged potential regulatory risks from a second Trump administration, including possible restrictions on share buybacks and dividends alongside increased capital expenditure requirements. Such measures could pressure earnings for established contractors that have relied heavily on returning capital to shareholders.
The Iran conflict has prompted caution from Federal Reserve officials, who are monitoring potential economic fallout including energy price volatility. Iran remains unwilling to negotiate reopening the Strait of Hormuz while under military attack, according to Bloomberg reporting, keeping energy markets on edge despite limited stock market reaction to defense names.
For investors, the defense sector presents a complex trade-off. Geopolitical tailwinds and record defense spending commitments—global military expenditures reached an estimated $3 trillion in March 2026—are offset by premium valuations and structural shifts toward next-generation technologies. Traditional contractors face the dual challenge of justifying rich multiples while adapting procurement models to a new era of cost-conscious modern warfare.