European defence stocks: More ammunition, or all out of firepower?
European defence stocks surged in early March as leaders from the UK, France, and across Europe pledged continued military support for Ukraine. The announcement came just days after a tense exchange at the White House between US President Donald Trump and Ukrainian President Volodymyr Zelensky, adding urgency to Europe's push for greater security independence. Top European defence stocks soared, with major players delivering strong gains amid heightened investor enthusiasm.
A new layer of uncertainty then emerged when President Trump announced a pause in US military aid to Ukraine, which could force European countries to step up their own military support.
The defence 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 defence 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 defence policy.
The recent announcement that the US is pausing military aid to Ukraine has intensified the focus on European defence autonomy. Many European governments are signalling a readiness to boost defence spending, with some aiming to increase budgets to as much as 3% of GDP. This shift could add substantial momentum to the sector, providing a strong tailwind for defence 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 defence systems. This trend is further supported by the European Council's discussions on easing fiscal rules to accommodate higher defence spending.
Risks and challenges: Caution is warranted
Every rally has its risks, and the defence sector is no exception. Political uncertainty, particularly around the US administration's stance on Ukraine and the trans-Atlantic relationship, could trigger market swings.
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 defence stocks.
Economic challenges could also weigh on the sector. Many European countries face fiscal constraints, and balancing increased defence budgets with social spending might slow the growth trajectory. Additionally, while some stocks have posted impressive gains, investors must consider whether there is still room for growth or if the market is becoming vulnerable to even minor disappointments as many defence stocks are trading at high valuations.
Long-term growth potential: Why defence stocks could still have legs
While there are clear risks, the defence 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. The push for increased defence 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 defence sector. This initiative would help maintain growth momentum even if fiscal pressures rise.
Innovation is also a key driver. European defence companies are investing in advanced technologies such as air defence systems, digitalised equipment, and software-defined solutions. There is a growing consensus among European policymakers that developing and producing European-made defence systems could reduce reliance on US imports, aligning with broader geopolitical strategies.
Takeaways for investors
The following considerations could help investors navigate both the opportunities and potential pitfalls of this market.
- Diversify your defence 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 defence contracts, and geopolitical developments closely.
- Gradual exposure: If you are not yet invested but would like exposure, consider a phased approach to entering the theme.
The European defence industry is at a critical juncture. The momentum is strong, but so are the risks. For investors, this could be an opportunity to capitalise on a long-term trend—provided they remain vigilant, diversified, and strategic. In a world where security is increasingly crucial, defence 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.
