Quarterly Outlook
Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?
John J. Hardy
Global Head of Macro Strategy
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European defense stocks: More ammunition left or out of firepower?
Jacob Falkencrone
Global Head of Investment Strategy
Key points:
- Long-term opportunity: The European defense sector is not just experiencing a short-term rally but may be at the start of a structural bull cycle, driven by increased military spending in Europe and strategic policy shifts toward greater defense autonomy.
- Balanced investment approach: A diversified approach can help investors manage risks while gaining exposure to the potential growth of the defense sector.
- Stay cautious: While the growth potential is strong, the theme is already up significantly, raising the question of how much longer this momentum can last amid high valuations and geopolitical risks.
“Sometimes the best offense is a strong defense—both on the battlefield and in your portfolio.”
European defense stocks surged on Monday as leaders from the UK, France, and across Europe pledged continued military support for Ukraine. At a high-stakes meeting in London this weekend, British Prime Minister Keir Starmer announced progress toward forming a "coalition of the willing" in which Europe will lead the charge for securing peace and seek to involve the US. The announcement came just days after a tense exchange between US President Trump and Ukrainian President Volodymyr Zelensky, adding urgency to Europe's push for greater security independence.
Defense companies were quick to reflect this optimism. Top European defense stocks soared, with major players delivering strong gains amid heightened investor enthusiasm. The Stoxx Europe Aerospace and Defense Index recorded its biggest one-day gain since November 2020, rising more than 8% amid heightened expectations for increased defense spending across Europe.
A new layer of uncertainty emerged Tuesday as President Trump announced a pause in US military aid to Ukraine. This decision could force European countries to step up their own military support, potentially driving further gains for European defense stocks.
“The current geopolitical landscape is driving a clear need for increased military spending across Europe. This dynamic not only strengthens defense budgets but also paves the way for European defense companies to step up as global leaders in the industry.”
The defense sector has been on the radar of investors for a while, but the latest developments bring the critical question into focus—can this rally last, or are we nearing a peak?What's driving the rally?
The rally in European defense stocks is being driven by more than just geopolitical tensions. While the ongoing war in Ukraine and the uncertainty surrounding US foreign policy have undoubtedly played a role, the surge is also underpinned by a broader shift in European defense policy. The recent announcement that the US is pausing military aid to Ukraine has intensified the focus on European defense autonomy. Many European governments are signaling a readiness to boost defense spending significantly, with some aiming to increase budgets to as much as 3% of GDP. This potential shift from the current levels could add substantial momentum to the sector, providing a strong tailwind for defense stocks.
Moreover, investor interest in the sector isn't merely reactive. Many have positioned themselves early, anticipating a prolonged growth phase as Europe seeks to enhance its military capabilities and reduce reliance on US defense systems. This trend is further supported by the European Council's discussions on easing fiscal rules to accommodate higher defense spending, which would create a more supportive environment for defense companies to thrive.
Over the past year, the Saxo Defense theme basket has delivered an impressive performance, up 73.88% significantly outperforming its benchmark (MSCI World), which gained 16.17% in the same period, showcasing the sector’s strong momentum. This basket, covering eight top players in the industry, offers investors a diversified and accessible way to tap into the defense sector’s potential upside while managing individual stock risks.
Over a five-year period, the basket has returned 356.92%, compared to the benchmark's 92.38%, showcasing its long-term strength. Below is a look at the performance of the basket and the eight stocks in it. The strong performance of these stocks highlights the sector's momentum.
Saxo Defense theme basket: Performance and composition as of March 3 2025
Risks and challenges: Caution is warranted
Every rally has its risks, and the defense sector is no exception. Political uncertainty, particularly around the US administration's stance on Ukraine and the transatlantic relationship, could trigger market swings. Despite the sector’s strong performance, it has shown sensitivity to geopolitical events, with noticeable volatility as a result.The suspension of US military aid to Ukraine adds another layer of uncertainty. If European nations cannot fill the gap left by the US, this could dampen the expected growth trajectory for some defense stocks.
Economic challenges could also weigh on the sector. Many European countries face fiscal constraints, and balancing increased defense budgets with social spending might slow the growth trajectory. Additionally, while some stocks have posted impressive gains—such as up to 1,000% since the Russian invasion in 2022—investors must consider whether there is still room for growth or if the market is becoming vulnerable to even minor disappointments as many defense stocks are trading at high valuations. Moreover, supply chain challenges may pose an issue. The high demand for military equipment has exposed supply chain bottlenecks, particularly for ammunition and advanced technologies. While the EU's Act in Support of Ammunition Production aims to address this, improvements may take time.
Long-term growth potential: Why defense stocks could still have legs
While there are clear risks at the front line, the defense sector might only be at the beginning of a multi-year growth cycle. Analysts suggest that this is more than just a short-term rally—it could be the dawn of a longer structural bull cycle for European defense stocks. The push for increased defense autonomy, combined with consistent government support, sets the stage for sustained growth through the early 2030s.European leaders are not only boosting military budgets but also focusing on strategic long-term investments. Some countries are exploring the potential of establishing a European rearmament bank to tap into the continent’s savings pool, providing long-term financial stability to the defense sector. This initiative would help maintain growth momentum even if fiscal pressures rise.
Innovation is also a key driver. European defense companies are investing in advanced technologies such as air defense systems, digitalized equipment, and software-defined solutions. There is a growing consensus among European policymakers that developing and producing European-made defense systems could reduce reliance on US imports, aligning with broader geopolitical strategies. The recent US decision to pause military aid to Ukraine could further accelerate this trend. This shift not only strengthens Europe's defense independence but also explains why European defense stocks have outperformed their American counterparts recently.
Takeaways for investors
While the defense sector could offer an attractive long-term investment opportunity, the sector is not without risks. The following considerations could help investors navigate both the opportunities and potential pitfalls of this dynamic market.- Diversify your defense exposure: Consider not only a few top names but spread your risk by taking exposure to a broader range of companies. This approach allows investors to participate in the sector's upside without the need to select individual stocks, reducing the complexity and risk of concentrated bets.
- Stay nimble: Monitor government budgets, major defense contracts, and geopolitical developments closely. Given the sector's sensitivity to political headlines, being agile can help manage risks.
- Gradual exposure: If you are not yet invested but would like exposure, consider a phased approach to entering the theme. Given the high expectations and recent surge, starting with a small position and gradually increasing exposure on pullbacks can help manage risks and avoid buying at elevated valuations.
“In uncertain times, strong defense stocks can offer more than just portfolio stability—they can be a source of growth and opportunity.”
The European defense industry is at a critical juncture. The momentum is strong, but so are the risks. For investors, this could be an opportunity to capitalize on a long-term trend—provided they remain vigilant, diversified, and strategic.
In a world where security is increasingly crucial, defense stocks might continue to shine. However, in a market where expectations are sky-high, those who combine conviction with caution may come out on top.
Whether you’re a seasoned investor or just starting out, a thoughtful strategy can help ensure you don’t just survive but thrive in today’s unpredictable market landscape. The impressive recent returns reflect the sector's potential and highlight the importance of a diversified and strategic approach to capturing potential upside while managing risks effectively.
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