When thinking about the top funds and stocks to invest in, defence is a sector that many investors have avoided historically based on environmental, social and governance (ESG) concerns.
However, ever since Russia’s invasion of Ukraine, there has been a shift in attitudes with many starting to believe that strength among Britain and its European allies is essential to securing and maintaining peace in the face of Russian aggression.
Now, a fiery confrontation between Trump and Zelenskyy, and the announcement that America will suspend military aid to Ukraine has brought concerns about European security to a head, with significant implications for defence spending.
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European leaders have responded by redoubling their pledges of support to Ukraine as they fear an American retreat from Europe.
With talk of increased defence spending across Europe, defence firms have seen their stocks shoot up in recent days. We look at why investors have rallied behind them, and whether you should invest in defence.
The build-up to America’s retreat
On the US election campaign trail last year, Donald Trump promised he would see the end of the war in Ukraine within days of his administration taking over.
The president was reluctant to continue the previous administration's support for Ukraine and criticised fellow NATO countries for not reaching the group’s target of spending 2% of GDP on defence.
This underinvestment has long been a bug bear of Trump and his team who believe Europe relies too much on American defence guarantees.
Now, in his second month in office, Trump is trying to fulfil that pledge – just not in a way that Ukrainians might want.
Last month, Trump spoke to Russian president Vladimir Putin about ending the war without consulting European or Ukrainian leaders, effectively bringing Putin in from the cold.
Trump then sent US officials to speak with Russian representatives in Saudi Arabia – so-called “peace talks” that Ukrainian president Volodymyr Zelenskyy was not invited to.
At the same time, vice president JD Vance delivered a speech at the Munich Security Conference, telling Europe it needed to “step up in a big way to provide for its own defence”.
The more than subtle implication was that the US is serious about its new policy of isolationism. This is a marked shift in direction. Since the end of the Second World War, the US has been a reliable ally in helping to maintain peace in Europe.
In response, European leaders scrambled to attend a summit in Paris on 17 February, trying to put their differences aside and come to an agreement on how to bolster European security and support a peace deal in Ukraine – crucially, a deal that involves and is acceptable to Ukraine rather than one brokered between Trump and Putin.
Defence stocks slowly started to increase in value as investors sensed that renewed interest in spending on national security was on the horizon across the continent.
A steeper rally in defence stocks occurred towards the end of the month after Ukrainian president Zelenskyy met team Trump at the White House last Friday (28 February).
The meeting saw a catastrophic breakdown in communications between Trump and Zelenskyy as the American president hounded his Ukrainian counterpart in front of the world’s media before the visit was cut short.
In the aftermath, European leaders flocked to a summit led by Keir Starmer in London to discuss the future of their support for Ukraine on Sunday.
While few concrete plans were announced, leaders in Europe redoubled their support for Ukraine and confirmed military aid would continue to flow. Additionally, Starmer said the UK would add another £1.6 billion in UK export finance for Ukraine to buy missiles, on top of the £2.2 billion loan announced on Saturday.
The prime minister also announced that defence spending in the UK will increase to 2.6% of GDP by 2027, injecting a further £13.4 billion into the defence budget.
How have defence stocks responded?
In the wake of the spat in Washington and summit in London, investors have rallied behind defence stocks across Europe, as they anticipate firms will take advantage of a boost in defence spending.
In Britain, the announcement of £13.4 billion more in the defence budget has boosted the prospects of its leading defence firms.
BAE Systems has seen an astounding rally, with its share price jumping up around 30% since the start of last month.
Investors also rallied behind Rolls-Royce, whose share price has risen by around 31% since the start of February.
This enthusiasm also extended to Babcock International whose stock rose by around 28% in the same time period.
On the continent, European defence stocks have also risen in recent weeks. The share price of Rheinmetall, the largest defence firm in Germany, jumped by around 46% since the start of February. Meanwhile, French aerospace and defence company Thales is up around 43%.
Outlook for the sector – should you invest in defence stocks?
With increased defence spending already being announced in Britain, and an increase anticipated in the rest of Europe, what is the outlook for the sector?
Currently, NATO requires all member states to spend 2% of GDP on defence each year, although recent reports suggest it could be considering upping this to 3% per year by 2030.
“Already, EU president Ursula von der Leyen has proposed that defence be exempted from EU limits on government spending,” said Hector McNeil, co-chief executive at HANetf, a provider of exchange-traded funds.
Defence stocks are likely to continue to rise over the longer term as a result of any spending increases, as they have done since 2022 when Russia invaded Ukraine.
“With European leaders scrambling to reinforce their military capabilities after the US distanced itself from security commitments, defence companies stand to be major beneficiaries,” said Nigel Green, CEO of deVere Group.
This will not be a short-lived surge, Green thinks, as he predicts the recent rise is just “the beginning of a fundamental realignment that will shape markets for the foreseeable future.”
This is, in part, because the Trump administration has refused to provide clear security guarantees for Europe, instead making it clear that Europe will have to shoulder most of the burden.
Green says “the market is already waking up to this reality” and suggests “[investors] who act now stand to gain the most”.
“With global instability unlikely to fade anytime soon, exposure to defence provides an essential hedge. It’s a sector backed by deep-pocketed government spending, insulated from consumer-driven volatility, and poised for structural growth,” he said.
“The future of global security is shifting, and markets are responding. The biggest mistake investors could perhaps make is underestimating the scale of change unfolding before them.”
Which firms stand to benefit from increased defence spending?
Unsurprisingly, the firms that stand to benefit most from an increase in national security spending in the UK are domestic defence companies.
Matt Dorset, equity analyst at Quilter Cheviot, cites BAE Systems as a particularly strong contender, saying: “it is the UK’s preeminent defence company involved in the production of submarines, fighter jets, combat vehicles, missiles, electronic warfare systems, naval ships, and many more. BAE currently generates 26% of its sales in the UK, and this could grow as domestic defence spending rises.”
But many other firms also stand to benefit.
Qinetiq is in a “strong position” according to Dorset, not least because the firm is “exposed to faster growing areas of defence spending including research and development and testing and evaluation, which should be bolstered by additional spending commitments”.
Babcock already has “a large order backlog which should increase as defence spending rises”, says Dorset as he also predicts this will increase as more money is spent on defence. “Babcock’s diversity across land, marine, and nuclear equipment and services provides multiple avenues for growth,” he added.
Finally, Dorset also thinks Chemring could benefit from the government’s cash injection, saying the firm “has global exposure, but 45% of its sales in the UK, making it a likely material beneficiary of increased UK defence spending”. The firm also has exposure to other European countries and is “increased traction in Europe and the UK.”
What about defence stocks outside Europe?
Jason Hollands, managing director at investment platform Bestinvest, says while it may be alluring to focus exclusively on UK-listed firms, investors would be better taking a global approach.
He explains that the biggest names globally are US firms, such as Lockheed Martin, Raytheon, Northrop Grumman, and General Dynamics.
Explaining the benefits of a global investment approach, Hollands says: “The high-tech nature of modern armaments means multiple firms can be involved in producing fighter jets, missiles, and warships, so defence projects are highly inter-related and typically benefit multiple firms rather than single suppliers.
“Governments also purchase equipment from global suppliers too and do not narrowly restrict themselves to domestically-based firms.
“For example, the UK’s most advanced fighters currently are the F35-B, whose main contractor is US firm Lockheed Martin, but with components made by both UK-listed BAE and Rolls-Royce.”
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