The S&P 500 (SPX) opened sharply lower on Tuesday following a weak earnings report from Snap, Inc., states Jon Markman, editor of Strategic Advantage.

The social media company blamed its poor financial performance on rising inflation and the war in Ukraine, which is a lame excuse.

At the session low the benchmark S&P traded all the way back to 3,875, 2.5% off the previous close. The index rallied late in the session to close at 3,941, a loss of only 0.8%.

While bulls should be encouraged by the late advance, the magnitude of the early decline, and the cause is alarming. Operational issues at Snap should not be enough to shake buyers from long positions, especially given the extent of the 2022 selloff this far.

The early weakness is an indication that a capitulation bottom has not yet occurred. Weak holders have not been replaced with stronger hands in the bull camp. That’s a problem.
In the interim, I’m still looking for bears to concede a rally for the S&P 500 to the 20-day moving average. That level is now 4,060, and I expect bears will reload short positions there. Critical support remains at 3,860 on a closing basis.

The Upshot

The Dow (DOW) managed to exit negative territory and end 0.2% higher at 31,928.62. The tech-heavy Nasdaq (NDX) fell by 2.4% to 11,264.45.

Communication services, consumer discretionary, and technology bore the brunt of an intraday sell-off while consumer staples and utilities led gainers.

The US 10-year yield plummeted by 10.1 basis points to 2.76% after reaching its lowest intraday level since mid-April earlier in the session. West Texas Intermediate crude oil futures were down $0.51 to $109.78 a barrel.

Breadth favored decliners two-one, and there were 749 new lows vs 54 new highs. Big caps on the new high list included Exxon Mobil (XOM), ConocoPhillips (COP), Corteva (CTVA), Xcel Energy (XEL), and Consolidated Edison (ED). That's energy and utilities at the vanguard.

Snapchat (SNAP) plummeted 43% after the Snapchat parent said in a filing it sees second-quarter sales falling below the low end of its projected range, citing a faster-than-anticipated deterioration of the macroeconomic environment. The downbeat forecast was notable since the firm offered initial guidance just a month earlier, with checks now pointing to incremental weakness in Europe, Oppenheimer said in a research note Tuesday.

Facebook and Instagram-owner Meta Platforms (FB) plunged 7.6%, among the worst performers on the Nasdaq 100 together with Chinese mobile platform Pinduoduo (PDD), which declined 8.6%.

In economic news, the flash manufacturing reading from S&P Global fell to 57.5 in May from 59.2 in April and the Richmond Fed's reading fell to -9 from +14 after regional data from the New York and Philadelphia Federal Reserve banks indicated a slowdown in the sector. Additional regional manufacturing data will be released before the ISM's national manufacturing reading on June first.

The flash services reading from S&P Global declined to 53.5 in May from 55.6 in April, while the Philadelphia Fed's index fell to 23.4 from 29.3 and the Richmond Fed's index fell to eight from 13, suggesting slower growth.

Now let's take a look at developments in the defense industry as NATO plans to expand.

Expanded NATO Will Shoot Billions to US Defense Contractors

Two more Nordic countries are joining the North Atlantic Treaty Organization. The real winners are American defense companies.

Finland and Sweden officially applied last week to join NATO. If admitted, they would join their Nordic neighbors in the alliance and open up a big new market for American defense contractors.

It would be a big win for Raytheon (RTN), Lockheed Martin (LMT), and Northrop Grumman (NOC).

The Russian invasion of Ukraine was a shockwave for Europe. For much of the last eight decades democracies on the continent have benefitted from a peace dividend. Elected leaders spent lavishly on social safety nets while largely ignoring that the world remains a dangerous place. The creation of the European Union expedited pacifism. Images of the destruction of Ukraine changed everything.

Before the February 24 war in Ukraine, support for NATO membership in Finland remained in the 20%-30% range. According to a report from the Associated Press, 70% of Finnish now want to join.

Sauli Niinistö, President of Finland summed up the shift succinctly.

Prior to the war, Finland was in control of its political allegiances, he says. While the country contributed to NATO’s air policing initiatives in the North Sea, Finland also shared an 830-mile border with Russia, resulting in many economic benefits. The invasion removed nonalignment as an option. Finland was either with Russia and defenseless or aligned with NATO.

Treaty obligations will mean a significant increase in defense spending. Finland has already ordered 64 new F-35 warplanes, the elite joint strike fighter developed by Lockheed Martin, Northrop Grumman, and BAE Systems (BAESY). The JSFs cost between $110 million and $135.8 million.

More importantly, aligning with NATO is a commitment to interoperability with the American defense ecosystem. This directly benefits the big US contractors. The market for their goods is expanding and they will face no competition for the foreseeable future.

In the short term, the revenue increase is going to be minimal. Defense contractors recognize sales when systems are delivered, and that can take several years. In the interim, the sector will benefit from supplementary bills passed to aid the war effort in Ukraine.

President Biden signed last week a $40 billion Ukrainian war package. The United States is sending existing equipment to the war-torn country. Those systems will later be replenished at an additional cost to US taxpayers. 

The Raytheon-made Javelin missile system has become a vital part of the Ukrainian defense effort. The heat-seeking, shoulder-mounted, anti-tank missiles are mostly responsible for destroying 664 Russian tanks, according to data published at Radio Free Europe.

In early April the US Department of Defense said that 7,000 Javelins had been deployed to Ukraine. For perspective, another DoD procurement document notes that Raytheon has never been able to produce more than 6,480 units during any 12-month span.

The F-35-ification of European armies might be a bigger deal, though. In addition to the cost of the units, corresponding ground support, spare parts, and maintenance, there is a lock-in factor. Europe is now committed to America-made gear for decades to come.

The benefit to Europe is peace of mind.

If Finland and Sweden are accepted into NATO, the countries would join their Nordic neighbors, Denmark, Norway, and Iceland. The five countries currently work together under the Nordic Defense Cooperation pact. Bringing NORDEFCO inside NATO would facilitate joint planning, cut off Russian maritime access to St. Petersburg, and strengthen the defense of the North Atlantic and Arctic sea routes.

American defense contractors are reliable technology partners. The companies are also backed-up by the largeness of the US defense budget, a record $810 billion in 2021. There is no appetite politically to decrease military spending. And that sentiment is spreading globally, thanks to the carnage in Ukraine.

Raytheon, Lockheed Martin, and Northrop Grumman are currently the best way to play this bigger trend. At share prices of $90, $424, and $443, the stocks trade at 15.5x, 14.9x, and 16.3x forward earnings respectively.

Given the prospect of new markets in Europe for the foreseeable future, these multiples seem inexpensive. Longer-term investors should consider buying shares into further weakness.

Learn more about Jon Markman here...