An investment guide to Europe's military resurgence

The European defence industry is experiencing a renaissance that no one saw coming five years ago. Countries that had neglected their armed forces for decades are now pumping billions into new tanks, aircraft and cyber systems. But with share prices sometimes rising by up to 16% in one day, prudent investors should ask themselves whether we've now entered speculative ground.

The European defence sector has been firmly in the spotlight in recent weeks. Since the invasion of Ukraine in 2022, European countries have significantly increased their spending on their armed forces. Recently, however, the growing gap between Europe and the United States has prompted our continent to assume greater responsibility for its own defence.

This, in turn, has led to a surge in European defence stocks. At the beginning of March, the STOXX Europe Aerospace & Defense Index jumped nearly 8% in one day, in its largest rise since 2020. Major players posted price gains of 14% to 16% at the time.

United States no longer merely offers a security umbrella

Heightened tensions on the world stage represent a breeding ground for the current interest in European defence stocks. The outbreak of the war in Ukraine was the first wake-up call for Europe's security policy. While many NATO countries have struggled for years to achieve their target of spending 2% of GDP on defence, there is now a growing awareness that this is a target that must be increased. Morningstar analysts expect European defence spending to reach around 3.1% of European GDP in 2029 and 3.5% by 2032.

Recently, Germany even relaxed its budgetary rules to spend more on defence – saying it will do whatever it takes. At the same time, European countries have shown greater willingness to cooperate with each other. European policymakers are pushing for defence autonomy: more joint development and manufacturing of European weapons so they can be less dependent on US imports.

The transatlantic political dynamic is certainly playing a role here. The new course set by Washington is increasing uncertainty, which has prompted Europe to take the lead in arming Ukraine and its own defence. The alarm bells are sounding in Belgium, too, as our government is trying to find additional billions to put into our defence.

Performance of defence stocks compared to European market indices

It's no surprise, then, that European defence stocks have received a lot of attention recently. Yet this is a trend that has been going on for more than just a few weeks. Defence stocks have outperformed the wider market as a whole by a significant margin in recent years. Since 24 February 2022 – the day Russia invaded Ukraine – the STOXX Europe Aerospace & Defense Index has gained 165% (as at 9 March 2025), while the STOXX 600 Europe index has increased by 19.5%. Since January, the Europe Aerospace & Defense Index has climbed by 27%, outperforming European bank shares.

Furthermore, it is also interesting to note that American defence stocks have gained less ground. Since the Russian invasion, for example, the S&P Aerospace & Defense Select Industry Index (USD) has risen by only 40% (as at 9 March 2025). This is due to the fact that the additional expenditure is now coming primarily from Europe itself, and investors expect European companies to receive the lion's share. Whereas US weapons companies used to benefit most from higher NATO budgets, we are seeing a shift as Europe makes a conscious move to invest in its own industry, leading European defence stocks to outperform their US counterparts. In short, those who have recently held defence stocks in their portfolio have achieved a significantly better return than those who invested in broader indices. This was accompanied by higher volatility, however (given that prices react to any news about war and politics).

Do you want to invest in European defence stocks?

It goes without saying that there are ethical considerations at play, as some investors avoid defence stocks on moral grounds. Institutional investors and ESG-oriented funds often avoid this sector or apply strict criteria when investing in defence companies.

Nevertheless, the debate on the role of defence in a broader ESG context continues to grow. Some analysts believe that defence companies play an essential role in protecting democratic values and stability, and that investing in defence does not necessarily mean you violate ESG principles. However, it remains an individual choice.

If you decide you want to invest, you have two approaches to choose from: select one or a few individual stocks yourself, or invest through wider-ranging trackers or funds.

Anyone who believes in specific companies can invest directly in individual stocks. This offers the benefit of a potentially higher return – if you pick some winners, they may outperform others by a significant margin. That said, it also means the risk is highly concentrated in one place. A disappointment (such as a major contract going to a competitor, or a sudden breakthrough towards peace) could hit individual stocks hard.

Alternatively, you can spread the risk by compiling your own basket of defence stocks, or simply invest in an ETF or investment fund that covers the sector. ETFs focusing on aerospace & defence are also available (some are global, while others focus specifically on Europe), allowing you to invest indirectly in a broad range of stocks in one transaction. Active funds are also responding to this trend.

Note, however, that despite the bright outlook, the defence sector is subject to unique risks. Firstly, there is a political risk, as unexpected geopolitical developments can lead to a shift in market sentiment at a moment's notice. The defence sector never stands still and is heavily influenced by the media headlines at any given time. Secondly, the sector is dependent on government budgets. In times of economic constraints, there may be a tendency to cut back on defence spending. For those wishing to invest, it may be wise not to adopt an all-or-nothing position, but rather to invest in stages and spread the timing risk.

Diversification across your entire portfolio remains essential. Although defence is currently an attractive sector, it is never wise to put all your eggs in one basket. Maintaining a balance with other sectors makes your portfolio even more resistant to shocks.

So, is it still worth investing?

The European defence sector is at the start of what appears to be a multi-year growth cycle. Increased military budgets and greater political will for rearmament represent a formidable pair. This suggests that defence stocks are more than just a temporary craze, and that there are fundamental, underlying drivers that could continue for years to come. From that perspective, you could say it is an attractive sector for long-term investments.

However, the exceptional price climbs seen in the last two years also call for caution. Valuations have risen and a lot of good news now seems to be priced in. The industry is trending upwards, which always means there is a chance of a reality check around the corner. Some defence stocks are already pricing in a significant amount of future growth, which involves a risk that even minor disappointments may lead to a correction.

Before you invest, please read the main characteristics and risks of financial instruments.

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