Defense stocks drop as deficit deal seems increasingly unlikely

There could be a new market for "sellers" on Wall Street: U.S. defense stocks.

Several top American weapons manufacturers’ stock prices were down Monday morning as it became increasingly clear that the special congressional debt panel would fail to find $1.2 trillion in federal savings.

A supercommittee failure, which could be formally announced on Monday, would trigger $600 billion in national defense spending cuts over a decade, making U.S. defense firms a less-attractive option for investors.

As of 11:15 a.m., Northrop Grumman’s stock price had dropped $2.72 a share on the New York Stock Exchange, while that of the world’s leading weapons maker, Lockheed Martin, was down $2.17. Raytheon’s stock price has fallen $1.42, and Boeing, which also has a robust commercial division, was looking at a $2.99 drop.

The drop could be evidence of “short selling,” according to defense business experts.

“In Wall Street parlance, short selling means betting that a stock will go down. You borrow shares and sell them, then buy new shares to return to the original owner later,” Loren Thompson of the Lexington Institute wrote recently. “If the stock goes down during the intervening period, you pocket the difference between the price at which you sold them and the price you had to pay to re-buy them.”

Short selling typically means there is growing skepticism about the long-term outlook for a specific sector.

Thompson points to a Nov. 16 paper published by Robert Ewers of Height Analytics, in which Ewers writes what the full implementation of the $600 billion sequestration cut would mean for defense stocks: “The defense complex is an obvious short in our view, because even the current low valuations do not reflect the tremendous effects of sequestration."

The cuts would not officially kick in until Jan. 2013, so there is time for Congress to reverse all or some of what would be required.

But there is ample uncertainty ahead for the defense industry and Wall Street. There is not yet a consensus outside of hawkish circles on Capitol Hill to undo some or all of the coming $600 billion in cuts. The Pentagon will send its 2013 budget plan to Congress in less than three months, meaning it will include myriad cuts to help it implement both the sequestration cut and an already approved $350 billion reduction over the same decade.

All this means, Thompson notes, that “defense shares could end up in limbo for much of 2012, with investors unsure how to act.”

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