The Stealth Sell-off Is Setting up the Big Rebound

The S&P 500 hit a record high earlier this month.

You’d never know it from looking at your portfolio.

According to Morgan Stanley, about 54% of the companies in the Russell 3000 are now at least 20% below their June highs.

That’s bear-market territory for more than half the market.

Nearly nine in 10 are down more than 10%.

Meanwhile, the index everyone watches sits within striking distance of an all-time high, propped up by a handful of tech giants.

A Record High Built on a Few Big Shoulders

The equal-weight S&P 500 gives every company in the index the same vote, regardless of size.

At the end of September, it was on pace for its seventh straight weekly loss, according to Dow Jones Market Data.

That’s only happened twice before: In 2002, after the dot-com bust, and in 2022, when the Fed was hiking rates as fast as it could.

At the same time, about 52% of S&P 500 stocks were trading below their 200-day moving averages, even as the index itself flirted with a record.

The last time the gap between the index and the stocks inside it was that wide was March 2000.

The reasons aren’t a mystery.

The 10-year Treasury yield jumped 54 basis points in September, to 5.29%. That’s the highest level since 2007.

On Sept. 16, the Fed raised rates for the first time since 2023.

And the war with Iran has kept oil prices elevated for months.

The Russell 2000 fell 5.3% in September alone, its worst month since March 2025.

Investors have noticed.

In the latest weekly survey from the American Association of Individual Investors, bears outnumber bulls 41.6% to 38.7%.

Bearish sentiment has now run above its long-term average of 31.5% for at least four straight weeks.

Dour is putting it mildly.

Defense Stocks Just Set a Losing Streak for the Record Books

Nowhere is the disconnect more glaring than in defense.

The SPDR S&P Aerospace & Defense ETF (XAR) closed at a record high on Aug. 14.

Six weeks later, it was down about 21%, officially a bear market, and riding the longest losing streak in the fund’s history, which dates back to 2011.

The iShares U.S. Aerospace & Defense ETF (ITA) posted seven straight weekly declines, its longest streak in LSEG data going back to 2006.

Its third quarter was its worst since the pandemic crash in early 2020.

In September, 42 of XAR’s 50 holdings finished in the red.

Lockheed Martin (NYSE: LMT) is down 23% from its high earlier this year.

Several of the smaller drone and space-hardware names that led the rally lost a fifth or more of their value in a single month.

What makes this so strange is the timing.

XAR’s prior long losing streaks came in early 2020 and spring 2022, when the whole market was coming apart.

This time, the S&P 500 fell just 1.4% over the same stretch.

According to Bernstein, defense stocks have gone from trading at a 15% premium to the S&P 500 in February to a 12% discount today.

The Market Is Pricing in a Peace That Hasn’t Arrived

The sell-off accelerated on Sept. 22.

That’s when reports surfaced that Iran had offered to reopen the Strait of Hormuz within seven days if the U.S. eased its military pressure. President Trump floated a negotiated end to the conflict at the United Nations the same week.

Defense stocks sank across the board.

Washington’s usual budget gridlock didn’t help, either.

But think about what a ceasefire actually changes.

The war has already burned through America’s stockpiles of missile interceptors.

Those don’t refill themselves when the shooting stops.

Lockheed builds the PAC-3 interceptors that Patriot batteries fire. Its shares jumped more than 3% on Wednesday after an analyst pointed out exactly that.

RTX (NYSE: RTX) entered the back half of the year with a record $289 billion backlog, up 22% from a year earlier.

The White House has proposed a $1.5 trillion defense budget.

And none of the bigger threats are going anywhere. Russia is still at war in Ukraine. China is still building the largest navy on Earth.

The Iran war will end at some point.

The generational shift in how America arms itself won’t.

History Is on the Side of Investors Who Stay Put

Deutsche Bank’s Jim Reid looked at every midterm election cycle going back decades.

The S&P 500 rose in 21 of the last 23, measured from one month before the election to two months after.

The median gain over that window was 7%.

We entered that window at the start of this month. The midterms are Nov. 3.

Bernstein, for its part, called the election “a clearing event and likely a good time to move into” defense stocks.

There’s a macro case, too.

U.S. employers added just 29,000 jobs in September, well short of expectations. July’s number was revised to a loss.

If the job market keeps softening, the Fed won’t be able to keep hiking for long.

Pair that with a potential Iran deal that eases oil prices and the backdrop that’s crushing stocks right now could flip in a hurry.

Where to Put Your Money Before the Turn

The last thing you want to do right now is sell into this.

The investors who bailed in early 2020 and late 2022 locked in their losses right before some of the biggest rallies in modern market history.

The ones who stayed put and kept buying came out far ahead.

Defense is the clearest example of a sector that’s been thrown out with the bathwater.

The prime contractors like Lockheed, RTX, Northrop Grumman (NYSE: NOC), and General Dynamics (NYSE: GD) are the steadiest way to play the rebound. Lockheed reports third-quarter earnings on Oct. 22, with more of the primes right behind it.

But the smaller companies that aren’t locked into decades-old programs of record are where the sharpest snapback is likely to come.

They fell the hardest. They tend to bounce the hardest, too.

That’s especially true in missile defense, where the stockpile math only points one way.

I’ve laid out my favorite small-cap Golden Dome play in a new report, including why I think it’s one of the most undervalued names in the entire sector right now.

You can get the details here.