Defense Stocks Could Rally After North Korea Saber-Rattling

Defense stocks traded higher on Monday morning after North Korea criticized the United States' "unilateral and gangster-like demand for denuclearization" following a weekend meeting with Secretary of State Michael Pompeo. The rejection evokes memories of renewed hostilities after past thaws in the U.S.-North Korea relationship, raising doubts about progress at the Singapore summit. It also raises the odds that the six-month correction in defense stocks is coming to an end, with this leadership group ready to lift off basing patterns and test bull market highs.  

This is especially good news for Lockheed-Martin Corporation (LMT), which fell to an 11-month low at $291 in June after breaking a multi-year trendline. The stock could still trade down to deep support, but it now has an opportunity to shake off selling pressure and restore its previously stellar technical positioning with a rally that tests new resistance between $320 and $330. (See also: Lockheed Martin Stock Could Drop to $260.)

The iShares Dow Jones US Aerospace and Defense Index Fund ETF (ITA) broke out above 2014 resistance following the November 2016 election and entered a powerful trend advance that posted nearly 60% gains into January 2018, when it topped out at $206. A quick decline to $184, followed by a failed breakout attempt, carved the outline of a rectangular correction that remains in force as we head into the second half of the year.

Declines into May and late June found support at the 200-day exponential moving average (EMA), typical in a healthy correction, while selling pressure escalated during the most recent downswing. The weekly stochastics oscillator fell into the oversold level at the same time, indicating a potential climax event that forced weak-handed shareholders out of positions. If so, the next upswing should attract relatively high volume as committed buyers add the ETF to long-term portfolios.

Dow component United Technologies Corporation (UTX) ended a multi-year uptrend above $120 in 2014 and rolled over in a double top breakdown that hit a three-year low in the lower $80s in 2016.  It completed a cup and handle breakout in December 2017 and posted an all-time high at $139.24 a month later, ahead of a volatile decline and failed breakout. The stock rallied back to broken support in May and has spent the past six weeks consolidating at that level.

A rally above $130 will restore the breakout, setting the stage for a test at the January high and continuation of the uptrend. That rebuilding exercise could take time, perhaps lasting into year end, so the best opportunities should come with long-term trades and multi-year investments. The fast-fingered crowd could take advantage of the rally above $130, but aggressive exits near $135 are recommended. (For more, see: How United Technologies Makes Its Money.)

Raytheon Company (RTN) has led its defense peers in recent years, posting a long series of higher highs and higher lows. The uptrend escalated at the start of 2018, generating three peaks into April's all-time high at $229.75. The stock turned lower into first quarter earnings and has continued to lose ground into July, posting a six-month low near $190.  It is also trading under the 200-day EMA for the first time since August 2015.

Resistance at $200 marks the most immediate barrier, with the narrow alignment of the moving average and broken May low. A downturn at that level may signal a false dawn for the defense sector, while a breakout opens the door to a stronger barrier at $215. Market players should watch buying volume closely during the recovery effort because the stock has posted a series of high-volume selling days since April. (See also: Lockheed Martin's Top Competitors.)

The Bottom Line

U.S. defense stocks could rally in reaction to a renewed freeze in the troubled U.S.-North Korea relationship. (For additional reading, check out: 3 Defense ETFs to Trade North Korean Uncertainty.)

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