Due to Musk and DOGE, Goldman Sachs is bearish on U.S. defense stocks

The "Department of Government Efficiency" (DOGE) aims to cut government budgets, raising concerns on Wall Street about government IT service stocks and defense stocks. Goldman Sachs stated that their stock performance may continue to be dragged down by DOGE throughout the year.

Goldman Sachs analysts Noah Poponak, Connor Dessert, and others indicated in their latest report that the "cost reduction and efficiency improvement" driven by DOGE could further weaken industry revenues and profit margins, putting pressure on government IT service stocks and large defense contractors.

In November 2024, following Trump's victory, DOGE was announced, led by Elon Musk and Vivek Ramaswamy, with the goal of "streamlining government structure and cutting wasteful spending."

According to the report, since Trump won the presidential election last November, government IT service stocks have averaged a 27% decline, and on the day after DOGE was established, government IT service stocks plummeted by 15%-20%. The stock prices of defense giants like Lockheed Martin (LMT) and General Dynamics (GD) have also been under pressure due to changes in contract terms and expectations of reduced spending.

Goldman Sachs stated:

"Given the risks related to client budgets, we maintain a relatively cautious stance on the government IT sector; considering revenue, profit margins, and valuations, we rate the defense sector as a sell."

Goldman Sachs: The industry pressure from DOGE has not been fully priced in

Goldman Sachs believes that the core logic of DOGE's operation is to compress government spending through technological substitution and contract reform.

For example, Army procurement projects were once paused to review financial terms. Although the U.S. Department of Defense clarified that "contracts have not been fully suspended," policy uncertainty led to a further 5% drop in government IT service stocks by the end of January this year, while the launch of "ChatGPT Gov" by OpenAI raised further market concerns (that generative AI could replace some outsourced services).

Goldman Sachs summarized that the sell-off in the government IT service sector concentrated around three major event timelines:

Policy shift expectations (November 2024): The establishment of DOGE marks the beginning of a tightening cycle for government IT budgets, leading to a collapse in investor certainty regarding industry revenue prospects.

Earnings reports expose risks (January 22, 2025): Companies like CACI exceeded profit expectations, but slowing order growth raised market concerns about short-term cash flow, with stock prices plummeting nearly 10% in a single day.

Technological and contract changes (January 27-28, 2025): The appointment of the new U.S. Secretary of Defense and the launch of ChatGPT Gov by OpenAI, combined with the dual impact of Army contract reviews and AI technology substitution, intensified market skepticism about the long-term logic of the industry.

Moreover, the recent earnings reports of the four major defense companies covered by Goldman Sachs also conveyed pessimistic signals:

Lockheed Martin (LMT): Due to additional costs related to classified aerospace projects, the stock price fell 9% on January 28. The company acknowledged that the Department of Defense may shift to "fixed-price contracts," which would compress profit margins.

General Dynamics (GD): Aerospace division revenue was 8% below expectations, and the guidance for free cash flow in 2025 was weak, leading to a 4% drop in stock price on January 29

Northrop Grumman (NOC) and L3 Harris (LHX): Although stock prices have stabilized for now, the slowdown in order growth has been reflected in the financial reports. LHX clearly stated that the new executive order may lead to delays in orders for the first quarter.

Goldman Sachs further warned that the current valuation does not fully reflect the impact of policies, “the proliferation of fixed-price contracts and the potential substitution by generative AI may trigger a secondary valuation downgrade,” and the agenda for DOGE may continue to suppress the industry until 2025.