North Korea just fired off another missile, raising the stakes in its nail-biting confrontation with the U.S. and Asian allies. Gold fluttered while the yen sunk, mimicking price action after past launches, but those knee-jerk reactions have so far failed to generate stronger trends. It is a different story with U.S. defense stocks, which have rocketed to new highs since the November election, anticipating these disturbing events as well as substantially higher domestic and allied spending that should grow profits well into the next decade.
Many top-tier defense names have hit technically overbought levels and are in need of multi-week pullbacks to lock in new support levels, but the sector continues to generate lower-risk plays in mid-tier contractors as well as former laggards getting a second look from value-oriented market players. Let's examine three of these potential winners, identifying price levels that should offer low-risk trade and investment entries. (See also: An ETF for Defense Spending Trends.)
Huntington Ingalls Industries, Inc. (HII) builds and repairs ships while providing technical consulting and engineering services to the Department of Defense. The stock hit an all-time low at $22.62 in 2011 and entered a strong uptrend that continued into the March 2017 all-time high at $220.68. The subsequent correction found support at the 200-day exponential moving average (EMA) in the low $180s in May, triggering a bounce to $200 followed by a June 2017 test that found willing buyers.
Huntington Ingalls shares completed a double bottom reversal in July and rallied within two points of resistance in August. The stock then eased into a symmetrical triangle that may complete the handle of a bullish cup and handle pattern, with a breakout generating a measured move target near $260. On-balance volume (OBV) has already lifted to an all-time high, generating a stiff tailwind for bulls looking for a lower-risk defense play. (For more, see: Huntington Ingalls Beats on Q2 Earnings and Sales.)
FLIR Systems, Inc. (FLIR) designs and manufactures surveillance and security systems. The stock bounced to $37.29 in 2011 following a long downtrend, pulled back into the upper teens in 2012 and tested resistance in 2014. Sellers took control once again, dumping the stock into a higher low at $25.12 in October 2015, ahead of a slow-motion recovery wave that reached resistance for the second time in December 2016.
The stock has been testing that formidable barrier for the past nine months, carving a rising channel that is finally gathering strength. This technical resilience should signal the first phase of a more important test at the July 2008 all-time high just above $45. A quick buying spike into that level will confirm the breakout above six-year resistance, which could inhibit further upside for several months at a minimum. (See also: FLIR Systems Realigns Business Units to Boost Operations.)
Hexcel Corporation (HXL) designs and manufactures structural materials for commercial and military space and aerospace products. The stock broke out above the 1988 high at $43.00 in February 2015 and topped out at $54.72 in August. The subsequent decline ended in the upper $30s in the first quarter of 2016, giving way to broad basing action followed by a November rally thrust that stalled at the prior high in December.
The stock has been carving a rectangular range since that time, with support near $50 and the 200-day EMA. In turn, this price action has nearly completed a cup and handle breakout pattern that could yield substantial gains after the stock pushes above the March high at $55.91. OBV has been lagging the price pattern in recent months, telling informed market players that greater institutional sponsorship will be needed for the breakout to reach the measured move target in the low $70s. (For more, see: Three Must-Own Defense Stocks.)
The Bottom Line
Big-cap defense stocks have posted substantial gains since the November election, currently denying low-risk entries, while mid caps have generated a number of interesting breakout patterns. As a result, this capitalization tier could offer the most productive sector plays into 2018 and beyond. (For additional reading, check out: How to Trade the Uptrend in Aerospace and Defense.)
<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>