Defense Stocks Fall 10% as Citi Warns Against Buying Dip

A key benchmark for the U.S. defense sector has come under significant pressure in the second quarter. Reporting from cnbc.com on May 15, 2026, highlighted that the iShares U.S. Aerospace & Defense ETF (ITA) has declined approximately 10% since the beginning of March. The sell-off has prompted major investment banks like Citi to express caution, advising clients against opportunistically buying into the recent weakness.

Why Has the Defense Sector Stumbled?

The recent downturn in defense equities follows a period of strong performance. A primary factor contributing to the reversal is heightened uncertainty surrounding future government spending. Debates in Washington over the fiscal year 2027 budget, which proposes a headline figure of $895 billion for national defense, have introduced concerns about the pace of contract awards and program funding.

Investors are weighing the possibility that budget growth may not keep pace with inflation or previous expectations. This could translate to margin pressure for major contractors who rely on long-term government contracts. The sector's valuation, which had expanded significantly over the past two years, is now being re-evaluated in light of these potential fiscal constraints.

some of the decline can be attributed to simple profit-taking. After outperforming the broader market for several consecutive quarters, institutional investors may be rotating capital into other sectors perceived to have more immediate growth catalysts. The 10% drop reflects a shift in sentiment from unbridled optimism to a more cautious stance on the sector's near-term outlook.

What is Citi's Rationale for Caution?

Citi's reluctance to endorse buying the dip is rooted in a combination of valuation concerns and a murky order-book outlook. The bank’s analysts point to stretched valuation metrics across the industry. Prior to the recent pullback, the defense sector was trading at a forward price-to-earnings ratio of nearly 20x, well above its five-year historical average of 17.5x.

This premium valuation was justified by expectations of sustained order growth fueled by global conflicts. However, Citi suggests that the most significant contract awards related to restocking allied inventories may have already been priced in. The bank is looking for evidence of a new, sustainable wave of orders before turning more constructive on the group.

the operational focus is shifting from new orders to execution and delivery on existing backlogs. Any signs of supply chain disruptions, labor shortages, or cost overruns on major programs could further erode profitability and investor confidence. Until there is greater clarity on budget allocations and margin stability, Citi maintains a neutral to underweight stance.

How Are Key Defense Stocks Performing?

The weakness is not isolated to the ETF but is visible across its largest components. Lockheed Martin (LMT), a bellwether for the industry, has seen its stock decline by over 12% since March 1. The company faces scrutiny over production timelines for its F-35 program, a critical revenue driver.

Similarly, RTX Corp (RTX) has experienced a pullback of roughly 9% over the same period. Investors are monitoring the financial impact of issues related to its Pratt & Whitney engine division. Even Boeing (BA), which has a significant defense and space division, has been unable to escape the sector-wide pressure, though its performance is also heavily influenced by its commercial aircraft business.

This broad-based decline among the industry leaders underscores the systemic nature of the current concerns. It is not a story of one company's missteps but rather a market-wide repricing of the entire sector's growth prospects for the next 12 to 18 months.

What Are the Risks and Counterarguments?

The primary risk facing the sector remains a contraction in U.S. and European defense budgets. A political shift toward fiscal austerity could lead to program cancellations or delays, directly impacting revenue for all major contractors. This represents the core of the current bearish argument.

However, a compelling counter-argument exists. The landscape of geopolitical tensions remains elevated, and global military spending continues to rise. Projections from the Stockholm International Peace Research Institute (SIPRI) forecast a 3.7% real-terms increase in global defense expenditures for 2026. This sustained global demand, particularly from Asia and Eastern Europe, could offset any potential softness in the U.S. market.

Investors with a longer time horizon might view the current 10% pullback as a strategic entry point. They are betting that the structural demand for advanced military hardware and technology will ultimately outweigh near-term budget cyclicality. The long-term thesis for defense spending remains intact for many.

Q: What are the largest holdings in the iShares U.S. Aerospace & Defense ETF (ITA)?

A: The ITA ETF is a market-cap-weighted fund, meaning its largest positions are in the industry's biggest companies. As of its latest reporting, the top three holdings are typically RTX Corp (RTX), Boeing (BA), and Lockheed Martin (LMT). These three companies alone often constitute over 40% of the ETF's total assets, making their individual performance highly influential on the fund's price movement.

Q: Does this downturn affect the commercial aerospace sector?

A: While some companies like Boeing and RTX have exposure to both defense and commercial aerospace, the drivers are different. The defense sector downturn is primarily linked to government budget concerns. The commercial sector's health is tied to airline passenger demand, fleet replacement cycles, and global economic growth. While supply chain issues can affect both, the fundamental demand drivers for a fighter jet are distinct from those for a passenger airliner.

Bottom Line

Uncertainty over government budget growth and stretched valuations are creating significant headwinds for defense stocks, overriding the supportive geopolitical backdrop for now.

Disclaimer: This article is for informational purposes only and does not constitute investment advice. CFD trading carries high risk of capital loss.