(Bloomberg) — It’s no secret that betting on defense suppliers when geopolitical tensions ratchet higher pays off — at least in the short term. But Wall Street says there’s more to this latest rally.

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Escalating tensions in the Middle East sent shares of weapons and plane makers to records last week, and the group continued to hold near an all-time high on Monday. A key gauge of the sector is now poised for its biggest annual jump in five years.

Yet the Federal Reserve’s easing cycle, the promise of lucrative deals for aerospace firms as airlines spruce up their fleets and the sector’s relatively low risk when it comes to the US presidential election are among a string of catalysts set to push the stocks even higher, according to analysts. Global instability is just the wildcard that often swings sentiment in their favor.

“This is more than just a geopolitical play,” said David Wagner, portfolio manager at Aptus Capital Advisors. He sees further upside in the defense and aerospace areas, despite current rich valuations.

The S&P 500 Aerospace & Defense Industry Index has already climbed 20% this year and is hovering near a record. If the advance holds through the end of 2024, that would mark the largest such increase since 2019. Top performers this year include Howmet Aerospace Inc., General Electric Co. and Axon Enterprise Inc. For all three, war-related military supplies comprise a relatively smaller share of revenue, though they benefit from defense spending.

Cash has poured into the $6.3 billion iShares US Aerospace & Defense ETF this month as well. The fund is already looking at its biggest inflow since April and trades a whisker away from an all-time high.

The stocks, often touted as haven assets, are comprised of two major sub-groups — defense and aerospace — offering investors a relatively diversified profile.

“Of the last four easing periods, defense has outperformed the S&P 500 by an average of 23%,” according to Ken Herbert, an RBC Capital Markets analyst.

Commercial aerospace stocks usually outperform the broader market by low-to-mid single digits during the first six months of Fed easing, though relative underperformance often follows after the end of the first year, Herbert wrote in a note to clients last week.

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But, this time around he expects aerospace companies to be buffered by order activity for commercial aircraft from major planemakers, such as Boeing and Airbus.

Both companies are working through higher-than-usual levels of backlog after years of supply-chain snarls. Airline operators, shaken by the lack of demand for air travel during the pandemic, have only recently resumed their usual expansion plans.

Even if an economic slowdown leads carriers to place fewer aircraft orders, the current backlog means any impact on production is likely negligible, Herbert noted.

Soaring values threaten to dent some of that optimism. The average aerospace stock in the S&P 500 trades at 28 times forward 12-month earnings, compared to 22 for the broader benchmark’s, and 27 for the tech-heavy Nasdaq 100.

“Valuations are rich for the group, so that may cap the upside,” said Keith Lerner, co-chief investment officer at Truist Advisory Services. “If the economy slows down more than expected or we see a short-term de-escalation in the Middle East that could also weigh on the group.”

If the Oct. 1 jump in aerospace stocks on Iran’s plan to launch a ballistic missile attack against Israel is any indication, investors aren’t largely pricing in a full-fledged escalation in the Middle East. Another flare-up could spur more share gains. On Monday, which marked one year of war, Israel Defense Forces said most of a barrage of rockets fired toward Tel Aviv by Iran-backed Hamas were intercepted.

“Unfortunately we are in a cycle of high and growing conflict around the world,” said Cole Wilcox, portfolio manager at Longboard Asset Management. “This is driving increased demand for defense spending that is likely to persist for a very long time.”

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