Investor sentiment towards US defence stocks has turned increasingly cautious. Since the US election in November, the largest publicly traded American defence contractors have significantly underperformed the broader market. The Dow Jones US Defence Index has declined 17 per cent, while the MSCI World Stock Index has gained 1.4 per cent over the same period.

A key factor behind this underperformance is President Donald Trump’s unconventional approach to economic and defence policy. Unlike traditional Republicans, who have historically favoured a laissez-faire stance on business, Trump has demonstrated a more interventionist style. As a populist, he frequently seeks to micromanage business operations, often dictating where companies should locate their manufacturing facilities. His vision of revitalising American industry prioritises reshoring production, even at the cost of higher prices for consumers.

Another critical distinction of this administration is its approach to military spending. While past Republican administrations have typically pursued aggressive defence policies, Trump has emphasised cost-cutting and military de-escalation. After his election, he appointed Elon Musk as the government efficiency czar, tasking him with identifying and eliminating waste and fraud within the Department of Defence’s $850 billion budget. Shortly thereafter, Defence Secretary Pete Hegseth instructed military services to find $50 billion in potential budget cuts — an 8 per cent reduction — to reallocate funds towards the administration’s defence priorities.

For major US defence contractors such as Lockheed Martin, General Dynamics, Northrop Grumman and L3Harris, the federal government is essentially their sole customer. This dependence on government contracts makes them particularly vulnerable to shifts in political policy and budgetary uncertainty.

Meanwhile, European defence contractors are experiencing a contrasting dynamic. The White House has increasingly signalled that European nations must take greater financial responsibility for their own defence. As the war in Ukraine continues, Trump’s discussions with European leaders have resulted in commitments to boost military spending. This has driven strong stock price appreciation for European defence firms. Germany’s Rheinmetall, for example, has surged 87 per cent year-to-date, while Britain’s BAE Systems is up 41 per cent.

Beyond projected cashflows, another key driver of stock prices is the degree of certainty around those cashflows. Higher uncertainty typically translates to lower valuations. With US defence budget cuts looming, investors are assigning greater risk to the “big six” American defence companies.

However, not all defence firms are equally exposed. Boeing and Raytheon, for instance, stand out because of their significant commercial aviation businesses. Raytheon, the third-largest producer of commercial jet engines, derives approximately 59 per cent of its revenue from the non-military sector. This diversification has helped RTX shares gain 16 per cent year-to-date.

Looking ahead, US defence companies with exposure to critical spending initiatives and long-term contracts may outperform their peers. In December, I highlighted here how the healthcare sector had been overly penalised owing to political uncertainties surrounding the new administration. Since then, the MSCI Healthcare Index has climbed 7.38 per cent, outpacing the broader MSCI World Stock Index’s 2.63 per cent gain.

At existing depressed valuations, select US defence stocks may present a similar investment opportunity.

• Bryan Dooley, CFA, is the chief investment officer at LOM Asset Management Ltd in Bermuda. Call LOM on +1 441-292-5000 or visit www.lom.com for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult their brokers if such information and/or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority