U.S. Defense Sector Valuation Shifts Under Potential Trump Executive Action: A Capital Allocation Strategy and Stock Performance Analysis

The U.S. defense sector has emerged as a cornerstone of economic resilience and strategic investment in recent years, driven by geopolitical tensions, technological innovation, and sustained government spending. As the 2025-2029 policy horizon approaches, potential executive actions under a Trump administration could further reshape the sector's valuation dynamics. This analysis explores how proposed budgetary, regulatory, and procurement reforms might influence capital allocation strategies and stock performance, drawing on recent market trends and authoritative data.

Trump's Policy Proposals: A Catalyst for Defense Sector Growth

The Trump administration has signaled a clear intent to prioritize military modernization and streamline defense spending. According to the Congressional Budget Office, the Department of Defense (DoD) budget is projected to rise from $850 billion in 2025 to $965 billion by 2039, with a focus on advanced technologies like AI-powered drones, hypersonic missiles, and space-based systems. This trajectory aligns with Trump's emphasis on "winning the future" through rapid innovation, as outlined in his April 2025 executive order on modernizing defense acquisitions.

A key policy lever is the push for NATO allies to increase defense spending to 5%, a move that could amplify global demand for U.S. defense exports and services. For instance, companies like Lockheed Martin and Northrop Grumman-already benefiting from FY 2025 Air Force modernization budgets of $188.1 billion-stand to gain from expanded international partnerships. Additionally, Trump's advocacy for an "Iron Dome-style" missile defense system underscores a long-term commitment to procurement programs that favor contractors with expertise in cybersecurity and missile defense as detailed in this analysis.

Capital Allocation Implications: Efficiency vs. Risk

The administration's regulatory agenda aims to address systemic inefficiencies in defense contracting. Executive actions such as canceling major acquisition programs that exceed 15% of their budget or schedule could reduce waste but may also introduce short-term volatility for firms reliant on delayed or canceled contracts. Conversely, streamlined procurement processes and a focus on commercial solutions could accelerate project timelines, enhancing returns for agile firms like Palantir Technologies Inc., which has already seen high valuations despite earnings gaps as reported in this article.

Investors must weigh these reforms against the sector's current leverage profile. The aerospace and defense industry's leverage ratio rose to 1.38 in Q3 2025, reflecting higher debt relative to equity. While this suggests potential for growth, it also raises concerns about long-term financial stability if cost overruns or policy shifts disrupt cash flows. Capital allocation strategies should prioritize companies with robust backlogs-such as RTX, which reported a $251 billion backlog in Q3 2025-and those demonstrating operational efficiency, like Northrop Grumman's 4% year-on-year sales growth.

Stock Performance: Optimism vs. Valuation Realities

The defense sector's stock valuation has been buoyed by investor optimism, with the industry's P/E ratio reaching 41.3x in December 2025-well above its 3-year average of 31.8x according to market analysis. However, discrepancies in trailing twelve months (TTM) data, such as a reported P/E of 936.7x, highlight volatility driven by varying earnings reports. This volatility could intensify under Trump's policies, particularly if budget increases outpace cost controls or if geopolitical tensions spur sudden demand spikes.

Recent stock performance underscores this dynamic. RTX surged to a record high of $182 in Q3 2025, fueled by a 2.27 book-to-bill ratio and $4.0 billion in free cash flow. Similarly, Lockheed Martin's 8.8% year-on-year sales growth and raised 2025 guidance reflect confidence in its $18.6 billion quarterly revenue. Yet, these gains must be contextualized against broader market trends: developed markets trade at a P/E of 27.5, while the defense sector's premium suggests investors are pricing in long-term growth rather than near-term fundamentals.

Strategic Considerations for Investors

For capital allocators, the interplay between Trump's policies and market dynamics presents both opportunities and risks. Key considerations include:
1. Sector Diversification: While defense stocks offer resilience during economic downturns according to market analysis, overconcentration in high-P/E names like Palantir could expose portfolios to valuation corrections.
2. Policy Monitoring: Investors should track the implementation of procurement reforms and budget allocations, as delays or shifts in priorities could alter company trajectories.
3. Geopolitical Exposure: Companies with international contracts (e.g., those supplying NATO allies) may benefit disproportionately from Trump's push for global defense spending as detailed in this report.

Conclusion

The U.S. defense sector stands at a pivotal juncture, with Trump's proposed policies poised to amplify its growth trajectory while introducing new layers of complexity. For investors, the path forward lies in balancing optimism about long-term government spending with caution regarding valuation metrics and regulatory risks. As the sector navigates this evolving landscape, firms that adapt to streamlined procurement processes and maintain strong operational margins-such as RTX and Lockheed Martin-will likely outperform, offering a compelling case for strategic capital allocation.