Defense stocks jump as U.S., Iran exchange attacks

Global defense stocks jumped early Monday as investors reacted to a dramatic military escalation in the Middle East over the weekend.

The sector was a rare bright spot amid a broader market sell-off triggered by fears of a wider regional conflict.

Germany’s Hensoldt and Britain’s BAE Systems were among the top performers in the Stoxx 600, both up around 5%. Defense names Thales, Renk, and Leonardo rose between 4% and 1.6%, paring earlier gains, while the broader Stoxx 600 index fell 1.2%, touching a two-week low.

Stateside, U.S. firms Lockheed Martin and Northrop Grumman rose 5.5% and 4.9% in premarket trading. Futures tracking the S&P 500 were down 1.1%.

With South Korean markets closed Monday, regional activity in Asia-Pacific defense sector was somewhat muted. Japan’s defense heavyweights Mitsubishi Heavy Industries and IHI rose about 3% each, while Singapore’s ST Engineering climbed 2.8%.

The moves come after the U.S. and Israel launched widespread attacks on Iran over the weekend that killed Iranian Supreme Leader Ayatollah Ali Khamenei, ending his 36-year rule. Retaliatory strikes by Iran against U.S. bases in the Middle East killed three U.S. service members.

Prospects of an escalation also led oil prices and energy companies’ shares to surge.

“It’s very much one of uncertainty at the moment that investors are grappling with,” said Patrick O’Donnell, Chief Investment Strategist at Omnis Investments.

“Equity markets are a little bit more uncertain about just how long this is going to drag on, for the implication for both growth and inflation that it will have the longer that it goes on,” O’Donnell told CNBC’s “Squawk Box Europe” on Monday.

“Really, it’s a question of… what’s the duration of this conflict?”

The conflict with Iran entered a third day on Monday, with U.S. President Donald Trump warning of further American casualties and saying the conflict could last for up to four weeks. 

In June last year, the U.S. and Israel launched air strikes that damaged three Iranian nuclear sites.

Carl Bildt, former Prime Minister of Sweden and co-chair of ECFR’s Council, said it was expected that Iran would strike back at the American military facilities in the Gulf region, “but now it seems like they are striking other targets across the Gulf as well.”

“That is surprising, but also highly disturbing, because, of course, the stability of the Gulf countries is important to us all, important to the global economy, important to the region,” he said.

European defense companies are approaching the end of this quarter’s earnings season, and Barclays analysts said there have been “more negatives than positives so far this year” despite stocks’ strong performance.

While Sweden’s Saab posted record results and backlogs, Barclays analysts said they “question the sustainability of its elevated growth,” in a note to clients published Monday. Saab shares rose as much as 7% early Monday, to quickly pare gains and trade largely flat by noon London time (7 a.m. Eastern time).

“Valuation is also at a significant premium and doesn’t justify the longer-term earnings trajectory, which could normalise faster than most peers,” they added.

Rheinmetall and Thales have yet to report full-year earnings.

— CNBC’s Lim Hui Jie and Lee Ying Shan contributed to this report