Defense Stocks in Play After Merger News

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Defense Stocks in Play After Merger News

On Monday morning, military stocks in the United States were trading higher after Raytheon Company (RTN) and Dow component United Technologies Corporation (UTX) proposed a $121 billion merger that would concentrate industry influence among a handful of mega-cap competitors. United Technologies has been on the acquisition trail for years, most recently concluding a November 2018 merger with the considerably smaller Rockwell-Collins.

The new Raytheon Technologies Corporation, which will be led by United Technologies CEO Greg Hayes, will be 57% owned by UTX stockholders. When the merger is completed, RTN shareholders will receive 2.34 shares, following a government review that could draw unwanted attention because the US government is likely to pay more for goods and services in a less competitive landscape, providing an opportune political target in the 2020 election.

Both equities will trade until the closure date, creating possible arbitrage and speculative possibilities, particularly if the connection encounters regulatory hurdles. Competitors such as The Boeing Company (BA) and Lockheed-Martin Corporation (LMT) rose in response to the announcement, hoping for improved profit margins, although these behemoths may use their substantial resources to stop the merger in the coming months.

In 2013, the iShares U.S. Aerospace and Defense ETF (ITA) completed a round trip to the December 2007 rally high of $73.00 and broke out, launching on a strong uptrend that halted around $125 in early 2015. A few months later, it plummeted to a two-year low before recovering and breaking out again in 2016. After the presidential election, the uptrend accelerated, resulting in a record increase that reached an all-time high of $218.83 in October 2018.

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The fund fell with the rest of the market in the fourth quarter, hitting a 17-month bottom in December, ahead of a 2019 relief rally that brought it within two points of the 2018 peak in Monday’s pre-market. A breakthrough may struggle to gain pace since mixed accumulation signals take time to catch up to price activity, but firm support above $200 should limit the downside.

Raytheon (RTN) was up more than 6% before of Monday’s opening bell, while United Technologies (UTX) was up around 3%. After the prior decade’s weak market, UTX followed a similar path as the military fund, bursting out to a new high in 2013. The uptrend stopped at $125 in February 2015, paving the stage for a difficult decline that finished in the lower $80s in the first quarter of 2016.

Despite gaining steam during the presidential election, the stock did not reach its 2015 peak until July 2017. Five months later, it competed a cup and handle breakout but made little progress, stopping at $130 in January 2018. A September breakthrough effort failed, and the December reversal concluded at a two-year high over $110.48. After printing a V-shaped pattern in May, it missed a second breakout effort and fell with the rest of the market towards the end of the month.

On Friday, the stock tested fresh resistance at the 50-day exponential moving average (EMA) of $132, while the merger announcement has closed the May gap between $133 and $135, creating low-risk buying opportunities on pullbacks between $132 and $135. On the other hand, it is still trading more than seven points below the 2018 high, and accumulation readings are locked in the midst of a nine-month range, suggesting that a breakthrough to new highs is unlikely until the fourth quarter at the earliest.

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The Bottom Line

Defense stocks are rising after United Technologies and Raytheon announced a $121 billion tie-up over the weekend. However, the transaction will not be completed until at least 2020, providing speculators and arbitrageurs plenty of time to develop lucrative tactics.

At the time of publishing, the author had shares of Lockheed-Martin in a family account.

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