Defence stocks surge on the back of strong military spending
Recent geopolitical shifts on both sides of the Atlantic Ocean have set the stage for a major increase in global defence spending.
Since the end of the Second World War, most of Western Europe has benefited from the United States security umbrella.
However, with US Vice President JD Vance's remarks at the Munich Security Conference, US President Donald Trump and Ukraine President Volodymyr Zelensky's arguing in front of the global media, and Elon Musk calling for the US to quit NATO, there are signs of growing US pivot away from NATO's principle of collective defence.
As a result, EU leaders are now moving swiftly to bolster their own security infrastructure to better prepare themselves for a world where the US is a less reliable security partner.
This shift could continue to have significant implications for defence-related equities.
Europe's whatever it takes moment
European countries had already been increasing their defence budgets. Pressure from the first Trump administration on NATO members failing to meet targets, along with Russia's invasion of Ukraine, has seen spending accelerate toward the current 2% of GDP target over the past decade.
However, it is now clear more will be needed. British Prime Minister Keir Starmer has said his government will spend an extra $US26 billion a year on defence to reach 2.5% of GDP, with an ambition to reach 3% in the next parliament.
Denmark has indicated that it will utilise an 'acceleration fund' to increase spending by $US17 billion and spend more than 3% of GDP on defence.
Most significantly, Germany's recently elected Conservative Party leader, Friedrich Merz, stated his 'absolute priority' is to strengthen European defence.
Merz looks set to bypass Germany's long-standing debt brake and allow defence spending above 1% of GDP to be excluded from government borrowing limits, with no restrictions on the volume or duration of this exemption.
Could these companies experience 'Nvidia style' top line growth?
EU defence spending is currently around $US340 billion or 2% of GDP. In the short-term, spending commitments are trending towards 3%, or an additional $US170 billion per year - and that is just within Europe. The US defence budget has increased by $US173 billion over the past five years.
To put these numbers into perspective, the mega-cap US tech hyperscalers' capital expenditure was $US219 billion in 2024. Defence contractors could see increases in demand comparable to what has occurred with AI infrastructure. Some are already.
Since Q1 2022, Rheinmetall, Germany's largest defence contractor, has grown its revenue by 19.4% p.a. to January 2025. Analysts are now forecasting top-line growth of around 40% for the current earnings season, before settling around 25% p.a. over the next two calendar years, translating to forecasted EPS growth of around 40% p.a.
Results like these have been translating into investor returns. European defence companies have outperformed even the US tech giants since Trump's election victory in November 2024.
Investors taking note
Defence ETFs have received US$2 billion in net flows over the last three months across the globe, amassing US$23 billion in funds under management.
Back home in Australia three defence ETFs listed on the ASX in the second half of 2024. These three funds have collectively gained over $100 million in funds under management since then, making defence-related equities one of the most successful ETF themes to launch in recent years in Australia.
Investors are using funds like BetaShares' Global Defence ETF (ASX: ARMR) to obtain exposure to high growth opportunities outside of the US's mega cap technology companies, which have come under pressure due to their high valuations.
With some serious tailwinds resulting from shifting tectonic plates in terms of geopolitics and associated higher levels of government spending, investors are looking to defence stocks for long-term structural growth.
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