The global defense industry has seen remarkable gains in recent months, with stocks of major defense contractors surging to new highs. A key driver behind this surge is former U.S. President Donald Trump’s shifting stance on military alliances, which has prompted increased defense spending across Europe and Asia. With Trump signaling that the U.S. may not automatically come to the aid of its allies, investors are betting on a long-term expansion of military budgets worldwide.
Defense Stocks on the Rise
Security-related stocks have performed exceptionally well this year, led by Germany’s Rheinmetall AG (RHM.DE), which has become the top-performing stock in the MSCI World Index. South Korean defense firms, including Hanwha Aerospace Co (012450.KS) and its subsidiary Hanwha Ocean Co (042660.KS), have also witnessed gains exceeding 100%, outperforming their regional competitors.
The defense sector’s growth is largely attributed to the European Union’s commitment to bolstering its military capabilities. European Commission President Ursula von der Leyen recently announced a proposal to extend €150 billion ($158 billion) in loans for defense spending. Additionally, Germany plans to establish a €500 billion fund to address critical defense investments, as stated by Friedrich Merz, the chancellor-in-waiting.
Impact of Trump’s Policy Shift
Trump’s approach to U.S. military commitments has fueled investor confidence in defense stocks. His decision to pause military aid to Ukraine has reinforced the notion that European nations must enhance their own defense industries. According to Keith Bortoluzzi, managing director at Impactfull Partners, Trump’s stance suggests that “Europe will have to ramp up their defense industry” in response to potential threats, particularly from Russia.
This policy shift has also led to increased interest in Asian defense manufacturers, particularly South Korea’s Hanwha Ocean, which is well-positioned to secure contracts from the U.S. Navy. Analysts at Bank of America have noted that Trump’s nominee for Navy Secretary, John Phelan, intends to leverage allied shipyards for naval production, creating potential opportunities for non-U.S. contractors.
Market Valuations and Investment Trends
The rapid surge in defense stocks has led to high valuations. Hanwha Ocean is now trading at 49 times its projected earnings, while Hanwha Aerospace and Rheinmetall have forward earnings multiples of 20 and 37, respectively. Despite these high valuations, analysts believe that continued global security concerns and rising military budgets will support further growth in the sector.
Some investors, however, are beginning to reevaluate their positions. Alec Cutler, a portfolio manager at Orbis Investments, has reduced exposure to European defense stocks, including Saab AB and Rheinmetall, citing concerns about potential pullbacks in military spending. However, he remains optimistic about the sector and has increased holdings in firms such as Leonardo SpA, which could benefit from ongoing defense investments.
Outlook for the Defense Sector
With ongoing geopolitical tensions and an increasing emphasis on self-reliant defense strategies, the global defense sector is expected to remain strong in the coming years. Rising military expenditures in Europe and Asia, coupled with potential conflicts in regions like Taiwan, are likely to sustain high demand for defense-related products and services.
Jung In Yun, CEO of Fibonacci Asset Management Global, highlighted the broader implications of this trend: “The realization that the U.S. will no longer provide protection for free will prompt the rest of the European nations to increase their defense budgets. Additionally, tensions between the U.S. and China over Taiwan and potential military clashes in the sea cannot be ruled out.”
As investors navigate the evolving geopolitical landscape, defense stocks are emerging as a compelling opportunity for those seeking exposure to the growing security sector. While valuations remain elevated, the long-term outlook for military contractors appears strong, driven by rising defense expenditures and shifting global alliances.
