U.S. defense stocks are trading higher on Monday morning after Raytheon Company (RTN) and Dow component United Technologies Corporation (UTX) proposed a $121 billion merger that would consolidate industry power among a handful of mega-cap rivals. United Technologies has been on the acquisition trail for years, most recently completing a hook-up with the much smaller Rockwell-Collins in November 2018.

UTX shareholders will own 57% of the new Raytheon Technologies Corporation, which will be run by United Technologies CEO Greg Hayes. RTN shareholders will receive 2.34 shares when the merger closes, following a government review that could draw unwelcome attention because the U.S. government is likely to pay more for goods and services in a less competitive landscape, offering an opportune political target in the 2020 election.

Both stocks will continue to trade until the closing date, generating potential arbitrage and speculative opportunities, especially if the hook-up runs into regulatory roadblocks. Competitors that include The Boeing Company (BA) and Lockheed-Martin Corporation (LMT) ticked higher after the news, in hopes of higher profit margins, but these giants could use their considerable resources to try and block the merger in the coming months.

Chart showing the share price performance of the iShares U.S. Aerospace and Defense ETF (ITA)
TradingView.com

The iShares U.S. Aerospace and Defense ETF (ITA) completed a round trip into the December 2007 rally high at $73.00 in 2013 and broke out, entering a strong uptrend that stalled above $125 in early 2015. It fell to a two-year low a few months later and turned higher, breaking out once again in 2016. The upside intensified after the presidential election, generating a historic advance that posted an all-time high at $218.83 in October 2018.

The fund plunged with U.S. markets in the fourth quarter, dropping to a 17-month low in December, ahead of a 2019 relief rally that reached within two points of the 2018 high in Monday's pre-market. A breakout could have trouble gaining traction because mixed accumulation readings need time to catch up with price action, but strong support above $200 should limited the downside. 

Chart showing the share price performance of United Technologies Corporation (UTX)
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Raytheon surged more than 6% ahead of Monday's opening bell, while United Technologies (UTX) traded about 3% higher. UTX followed a similar trajectory as the defense fund after last decade's bear market, breaking out to a new high in 2013. The uptrend ended near $125 in February 2015, giving way to a complex correction that posted a three-year low in the lower $80s in the first quarter of 2016.

The stock gained ground through the presidential election but didn't reach the 2015 high until July 2017. It competed a cup and handle breakout about five months later but made limited progress, stalling near $130 in January 2018. A September breakout attempt failed, while the reversal into December finally ended at a two-year low above $110.48. It failed a second breakout attempt after printing a V-shaped pattern into May and sold off with the broad market into the end of the month.

The stock tested new resistance at the 50-day exponential moving average (EMA) at $132 on Friday, while the merger news has filled the May gap between $133 and $135, setting up low-risk buying opportunities on pullbacks between $132 and $135. On the flip side, it's still trading more than seven points below the 2018 high, while accumulation readings are stuck in the middle of a nine-month range, predicting that a breakout to new highs may not happen until the fourth quarter at the earliest.

The Bottom Line

Defense stocks are trading higher after United Technologies and Raytheon announced plans over the weekend for a $121 billion hook-up. However, the deal won't close until 2020 at the earliest, giving speculators and arbitrageurs plenty of time to build winning strategies.

Disclosure: The author held shares of Lockheed-Martin in a family account at the time of publication.