Key Takeaways:
Market response is driven by both events and policy: Evidence from academic literature suggests defense stocks react quickly to geopolitical shocks, but longer-term outcomes are shaped by budget decisions, procurement cycles, and shifting expectations. The initial move reflects the event, while the follow-through reflects policy.
Recent conflicts show sector strength, with variation at the company level: Prime contractors have generally outperformed the broader market during recent conflict periods, but performance is not uniform. Differences in contract exposure, execution, and program mix can lead to dispersion even within a small group of companies.
Defense may offer differentiated behavior during market stress: The observed positive correlation between defense equities and the VIX suggests that contractors may behave differently during periods of rising volatility. This dynamic may be relevant when considering defense not just as a sector tilt, but as a potential diversifier within a broader portfolio.
A thematic ETF can help capture broader defense dynamics: DUTY is structured to focus on companies with meaningful defense exposure across systems, technology, logistics, and cybersecurity. For investors less focused on individual stock selection, this provides a way to access the underlying theme while managing company-specific risk.
Moving past the “conflict trade” narrative
Defense stocks are often treated as a reaction trade. A conflict breaks out, headlines move, and investors rotate into the sector. This insight takes a step back from that framing.
Instead of focusing on the event itself, the starting point is how markets tend to respond. Defense equities often react quickly to geopolitical shocks, but the more important story tends to unfold after the initial move. As policy responses take shape, budgets adjust, and contracts are awarded, those developments begin to filter through to company fundamentals, particularly for large prime contractors.
The first move is driven by headlines, while the follow-through is driven by policy. We begin with a review of the academic literature on how defense stocks behave during periods of geopolitical stress, then examine show those patterns have shown up in more recent conflicts.
The focus is on publicly listed prime contractors, where the connection between government spending and revenue is most direct. From there, we consider how these dynamics may fit within a broader portfolio diversification context.
The goal is not to position defense as a short-term trade, but to frame it as a policy-driven theme that can be approached in a more structured way, and allocated to through an ETF.
Market behavior: what do defense stocks respond to?
In the case of the Paris terrorist attacks, Apergis & Apergis (2016)1 find “a significant reaction on the terrorist attacks day… as well as on the days following the event,” with prices “quickly and adequately reflected.” They also observe “an upward trend in cumulative abnormal returns… over the post-attack period,” suggesting that the impact extends beyond the initial shock.
However, broader measures of geopolitical risk do not consistently translate into predictable returns. Apergis et al. (2017)2 find “no evidence of predictability of stock returns… emanating from the geopolitical risk measure,” although geopolitical risk “does predict realized volatility in 50% of the companies.” This indicates that while events can trigger price moves, the relationship between ongoing geopolitical tension and returns is less direct, even as risk levels increase.
What appears more consistent is the role of policy and spending. Gurdgiev et al. (2022)3 show that “defense budget announcements have complex and dynamic statistically significant positive impacts on defense company stock performance,” including effects from current, revised, and lagged budget decisions. This shifts the focus away from the event itself and toward how governments respond.
After analyzing the literature, we present our interpretation of a three-phase cycle for defense equity reactions. In short, defense stocks react quickly to discrete events, reprice as policy and spending responses become clearer, and then move into a phase where returns are less predictable and more dependent on execution and investor sentiment.
Immediate reaction (event-driven moves)
Short-term price movements tend to cluster around the event window. Using a [−5, +5] framework, Apergis & Apergis (2016)1 document statistically significant abnormal returns on and immediately after the Paris attacks. This supports the idea that defense stocks are sensitive to sudden geopolitical shocks and that these shocks are rapidly incorporated into prices.
Medium-term repricing (policy and expectations)
Beyond the initial move, the market begins to incorporate policy responses. Gurdgiev et al. (2022)3 find that budget announcements, including revisions and lagged effects, play a statistically significant role in shaping returns. This suggests that the repricing phase is driven less by the conflict itself and more by procurement decisions, funding commitments, and expectations of future cash flows.
Longer-term normalization (volatility and adjustment)
Over longer horizons, the pattern becomes more mixed. Apergis et al. (2017)2 show that geopolitical risk is more closely linked to volatility than to returns, while Gurdgiev et al. (2022)3 find that the positive impact of direct conflict participation is “almost fully moderated by the subsequent period negative reaction.” This points to a tendency for initial gains to be followed by periods of adjustment as investor expectations are reassessed.
Defense primes vs. the S&P 500 during recent conflicts
To move from theory to practice, it helps to look at how major defense contractors have performed during recent conflicts. The focus here is on a group of large, publicly listed prime contractors: RTX Corporation, Lockheed Martin, General Dynamics, and Northrop Grumman, measured against the S&P 500 Total Return Index on a percentage return basis.
Russia–Ukraine War (February 24, 2022, to March 20, 2026)
Across this period, each of the prime contractors delivered higher total returns than the S&P 500 on a total return basis.
This aligns with the earlier discussion around policy-driven repricing. The conflict triggered sustained increases in defense spending across NATO, along with replenishment cycles for munitions.
Israel–Hamas conflict (October 6, 2023, to March 20, 2026)
A similar pattern appears in the more recent Israel–Hamas conflict. Again, each of the same prime contractors meaningfully outperformed the S&P 500 over the measured period.
The drivers here include increased demand for air defense systems, precision munitions, and ongoing replenishment cycles, particularly as the conflict evolved and broadened regionally.
Defense equities and volatility: a diversification case?
Over a five-year period using 60-day lookback windows, the Dow Jones U.S. Defense Index has shown a positive correlation of approximately 0.69 with the VIX, while the S&P 500 has exhibited a negative correlation of roughly -0.83.
This suggests that defense equities have tended to move more in line with rising volatility, while the broader market moves in the opposite direction.
But unlike long volatility hedging strategies which can exhibit negative carry over time, defense exposure is tied to operating companies with underlying revenue from contract backlogs.
That distinction may be relevant when reconsidering defense not just as a sector tilt for alpha, but as an additional portfolio diversifier during periods of stock market stress.
From individual contractors to a diversified defense basket
Even within this small group, performance dispersion exists. Contract mix, program execution, exposure to specific systems, and capital allocation decisions all play a role. Some companies benefit more directly from specific procurement cycles, while others may lag despite operating in the same sector.
This is where portfolio construction becomes relevant. While the sector itself has shown a consistent pattern of relative strength during these periods, the outcomes at the company level remain dependent on factors that are difficult to isolate in advance.
If the objective is less about bottom-up analysis of individual defense contractors and more about capturing the broader dynamics discussed earlier, particularly how conflict and policy flow through the sector, ETFs can provide a more structured approach.
The U.S. Defense ETF (DUTY), which tracks the Solactive U.S. Defense Index which is designed to focus on companies with meaningful exposure to defense-related revenues, while limiting overlap with firms whose performance is driven primarily by commercial aviation cycles.
How DUTY’s methodology works
To maintain that focus, companies must derive at least 50% of their revenues from core defense activities. These are broadly grouped into four areas:
Defense systems and military platforms, including weapons, munitions, aircraft, naval systems, and missile and space-based defense technologies
Defense technology, such as sensors, radar, electronic warfare systems, and command, control, communications, intelligence, surveillance, and reconnaissance platforms
Logistics, simulation, and mission support, covering maintenance, training, supply chain, and operational readiness services
Cybersecurity and digital defense infrastructure, including network defense, encryption, threat intelligence, and secure communications systems
There are also baseline universe screens. Eligible companies must be listed on the NYSE or NASDAQ, have a minimum market capitalization of $100 million, and maintain average daily trading volume of at least $1 million.
Weighting is based on market capitalization, but with constraints to manage concentration. Individual holdings are capped at 8%, while cybersecurity names are capped at 3% each and 25% in aggregate. The combined weight of positions above 5% cannot exceed 40% of the index.
The index is reviewed and rebalanced on a semi-annual schedule, with additional reweighting during the year to maintain alignment with market conditions.
A DUTY to give back to those who serve
There is also a charitable element embedded in DUTY. Aura ETFs Inc., as sponsor, intends to donate 10% of the Fund’s total annual management fees to to charitable organizations supporting military veterans.
The firm has also committed to a minimum donation of $150,000 during the fund’s first year of operations. It is important to note that these donations are made by Aura ETFs Inc. and are not expenses of the fund itself. Donation amounts may vary based on the ETF’s assets and revenue over time.
Related ETFs:
DUTY – U.S. Defense ETF
Additional Defense Insights
DUTY: Investment Case
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The VIX index is a financial benchmark designed to be an up-to-the-minute market estimate of the expected volatility of the S&P 500 Index
The Dow Jones U.S. Defense Index measures the performance of U.S.-listed companies operating in the defense subsector as defined by the Dow Jones Industry Classification System (DJICS). The index comprises constituents of the Dow Jones U.S. Index classified under the DJICS Defense subsector, which includes producers of components and equipment for the defense industry, such as military aircraft, radar equipment, and weapons systems.
Sources:
Apergis, Nicholas, and Emmanuel Apergis. “The 11/13 Paris Terrorist Attacks and Stock Prices: The Case of the International Defense Industry.” Finance Research Letters, May 2016.
Apergis, Nicholas, Matteo Bonato, Rangan Gupta, and Collins Kyei. “Does Geopolitical Risk Predict Stock Returns and Volatility of Leading Defense Companies? Evidence from a Nonparametric Approach.” Defence and Peace Economics, February 2017.
Gurdgiev, Constantin, Seán Henrichsen, and David Mulhair. “The Budgets of Wars: Analysis of the U.S. Defense Stocks in the Post-Cold War Era.” Defence and Peace Economics, November 2022.
