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Takeaway: Despite the sequestration, defense stocks are sitting near multi-year highs. Here's why and why it might not stay that way.

Here's an excerpt from a note that Industrials sector head Jay Van Sciver wrote to his insitutional clients earlier this week about the performance of  stocks in the defense sector.

He writes:

"Who would have thought that a couple of months after sequestration, many defense stocks would be sitting near multi-year highs? 

When consensus on a group is fairly uniform, it can present challenges and Defense has been heavily out of favor.  Easing concerns around the U.S. budget deficit and hawkish sentiment with respect to North Korea, Syria and Chinese hacking have no doubt helped boost the shares."

Defense Stocks Ignore Sequestration - Aerospace

Van Sciver continues:

"We would not chase defense shares here.  In a longer-term context, the post-sequestration rally is just a squiggle at the top of a defense spending driven mountain. 

As we understand it, much of the impact of either sequestration or whatever agreement supersedes it, should come in later years.  Further, orders received today will usually not generate revenue for months and years.  Military retirement, healthcare and other benefit costs are set to rise meaningfully in coming years, potentially crimping procurement spending. 

The nature of weapons seems to be shifting toward lower cost/unit unmanned drones and there are risks for contractors as this defense transformation plays out.  Reduced overseas commitments and a lack of prime contractor consolidation prospects may also be negative."