Opinion: How Defense Stock Prices Responded To U.S. Afghanistan Exit

evacuees from Afghanistan boarding U.S. military aircraft
Credit: Master Sgt. Donald Allen/U.S. Central Command

The abrupt victory of the Taliban in Afghanistan closed one chapter for defense but populated a new list of scenarios for the sector in 2021 and beyond. 

Markets also spoke about the changes the August events in Afghanistan could bring, though for the most part these were muted comments in contrast with multiple individual views that were proffered. Of course, markets are not always right, but they have a voice that is worth considering.

The fall of Kunduz to the Taliban on Aug. 11 could be seen as the start of the rapid unraveling of the U.S./NATO-backed government in Afghanistan. At that time, there were assessments that Afghanistan’s security forces could still hold off the new offensive, but these were measured in months, not days. Still, Aug. 11 could be seen as a useful demarcation point for when defense stocks started to reflect the possibility of a Taliban victory and what it could mean for future demand. 

There are three narratives for U.S. defense emerging from the Taliban victory and shambolic withdrawal from Kabul. One is that President Joe Biden’s approval rating will be irreparably damaged, and the Republicans will have better prospects in the 2022 midterm elections and in the 2024 national election. Another narrative is that the return of Taliban rule will mark a resurgence in global terrorism, with threats as dire as the 9/11 attacks against the U.S. more likely again. The third is that the end of the U.S. support for Afghanistan would free up resources to focus on competition with China.

If markets believe in those narratives, U.S. defense and services stocks should perform well, with the exception of stocks that would lose sales as a direct result of the change in Afghanistan. The global threat environment could arguably worsen, and there may be popular beliefs that Republican control of the White House and Congress would lead to higher U.S. defense spending than if Democrats control both ends of Pennsylvania Avenue or there is split party control.

Companies with direct Afghanistan exposure have seen their stock prices decline—PAE is the most prominent example: Its stock price dropped 21.5%. However, markets were not buying the rest of the U.S. narrative. From Aug. 11 through Sept. 10, the share prices of L3Harris, Lockheed Martin and Northrop Grumman declined 0.5%, 4.8% and 3.3%, respectively. Over this same period, the S&P 500 rose 0.2%. Shares of defense contractors whose services are the dominant source of sales also did not evidence significant change. Booz Allen, CACI, Leidos and SAIC fared a bit better than the largest U.S. primes but not discernibly better. SAIC was the best of that group, with a 1.3% price rise, although it reported positive earnings results on Sept. 2.

In anticipation of more resources allocated to defense of the Indo-Pacific, complex conventional weapons programs should benefit. The performance of the largest primes does not suggest markets buy that view, however. Naval shipbuilder Huntington Ingalls’ stock declined 5%

Another narrative is that allies are going to lose confidence in the U.S. over Afghanistan. If that were to transpire in 2021-22, there should be concrete moves by countries to increase their defense spending and assume a larger burden in global security. There are not as many pure defense stocks in Asia and Europe, but the evidence is mixed. Shares of BAE Systems, Hensoldt, Leonardo and Saab Group declined 4.4%, 8.3%, 1.6% and 3.8%, respectively, from Aug. 11 through Sept. 10. Elbit’s stock price increased 10.9%, but it reported better than expected earnings on Aug. 12. In South Korea, Victek declined 8% while LIG Nex1 rose 13.7%, and in Taiwan, CSBC fell 0.2% and Aerospace Industrial Development Corp. declined 8.7%.

The one exception to the price declines or mixed price action was India—though it may be a stretch to base a conclusion on two data points. Bharat Electronics rose 14.1% and Hindustan Aeronautics Ltd. increased 28.4%--which is the best-performing defense stock over the period. India’s security outlook has changed because the Taliban victory in Afghanistan could pose more risk in Kashmir, and an unstable Afghanistan may yet result in new challenges and instability in Pakistan. There are not defense stocks listed in Pakistan or in other regional markets that might further validate whether this is a market view.

There are other factors that weighed on defense equities over the past month besides Afghanistan. In the U.S., there is the fiscal 2022 budget, the potential for Congress to increase corporate tax rates and tax share buybacks and another standoff over the debt ceiling. Defense may appear relatively less attractive if there is more confidence in GDP growth. 

The markets’ verdicts may also be that it is simply too soon to make high-conviction investments in defense companies based on what Afghanistan under the Taliban will mean for global security. Time, as it always does, will tell.

The views expressed are not necessarily those of Aviation Week. 

Byron Callan

Contributing columnist Byron Callan is a director at Capital Alpha Partners in Washington.