Defense stocks added to gains on Monday and Tuesday after the drone strike on Saudi Arabia, with the uptick in geopolitical tensions encouraging sidelined investors to take exposure. The major sector fund is already trading at an all-time high after breaking out above 2018 resistance earlier this month and could outperform the S&P 500 into the 2020 election, when a reelected President Trump or a Democratic contender will open a new chapter for American firepower.

The rally is especially impressive because Dow component The Boeing Company (BA) is the biggest component in the iShares U.S. Aerospace & Defense ETF (ITA), with a 22% weighting. The stock is trading more than 60 points below March's all-time high due to the MAX 737 grounding, but that dark chapter is likely to close in the next six to nine months, providing an added boost to fund performance.

Chart showing the share price performance of Lockheed Martin Corporation (LMT)
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Lockheed Martin Corporation (LMT), the third highest-weighted component in the ITA fund, has done much of the heavy lifting in recent months, rallying more than 150 points off December's two-year low at $241. It's no accident that the world's largest and most profitable missile systems manufacturer has risen more than 1,400% since last decade's bear market, taking advantage of defense budget increases that have accelerated since a Republican took over the White House.

Ironically, the president-elect's tweet attack on Lockheed Martin offered an excellent buying opportunity in December 2016, with threats to look elsewhere for America's defense needs falling on deaf ears because there are few alternatives to the company's missile systems and aerospace technology in a world growing more dangerous by the day. As a result, setbacks for big-ticket items like the F-35 fighter jet have offered countless opportunities to buy the stock at a discount.

Chart showing the share price performance of the iShares U.S. Aerospace & Defense ETF
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The iShares U.S. Aerospace & Defense ETF came public in the low $50s in May 2006 and entered an immediate downtrend that posted a low at $44.99 in June. Two successful tests into August set the stage for a rapid recovery that lifted the fund to a new high in November. It posted impressive gains into the 2007 top at $73.00 and turned sharply lower with world markets during the 2008 economic collapse, hitting an all-time low at $28.33.

The fund completed a round trip into the 2007 high in 2013 and broke out, lifting above $125 in 2015. It paused at that resistance level into the summer of 2016 and broke out once again, gaining more than 60% into February 2018. Price action has carved two higher highs since that time, including this month's breakout above the October high at $218.83, rewarding a highly loyal shareholder base.

The uptrend is likely to reach the rising highs trendline and channel resistance above $235, completing the outline of a bearish rising wedge, but it will be hard to bet against this industry unless a Democratic dove rises in national polling ahead of the election. In addition, defense stocks have performed equally well in Democratic and Republican administrations because threats from North Korea, Iran, and other troublemakers haven't eased in nearly 40 years.

However, these issues show relatively strong correlation with broad-based market performance, so a recession or economic downturn that drops major benchmarks into a bear market won't spare the defense group unless we're engaged in a costly conflict. On the flip side, that conflict could easily trigger a breakout above wedge resistance, opening the door to upside toward $300 for the sector ETF.

The Bottom Line

U.S. defense and aerospace stocks are leading the broad market, posting new highs after drones attacked a Saudi Arabian oil field.

Disclosure: The author held shares of Lockheed Martin and the iShares U.S. Aerospace & Defense ETF in family accounts at the time at the time of publication.