Defense ETFs: The $1.5T Catalyst and Tactical Entry Points

The core event is a stark political signal. President Trump announced on Wednesday that his administration will request $1.5 trillion in military spending for fiscal 2027. That figure is a record high, representing a more than 50% increase over this year's $901 billion budget. The proposal frames this surge as a necessary "Dream Military" for national security, enabled by tariff revenues. Yet the immediate market reaction tells a different story. On the day of the announcement, shares of major defense contractors like Northrop Grumman, Lockheed Martin, and RTX fell.

This sell-off is the first tangible impact of a powerful political catalyst. The president didn't just propose more spending; he simultaneously issued an Executive Order targeting defense contractors' stock buybacks and distributions. The directive signals a direct shift in government leverage, threatening to cut off Pentagon purchases from firms that prioritize shareholder returns over production speed and capacity investment. For a sector built on long-term, stable contracts, this new threat to the financial relationship with its largest customer is a clear red flag.

The setup is now a classic tension between political ambition and market reality. The proposal itself is not law-it requires congressional approval and a formal budget submission that hasn't been made yet. The market's negative reaction suggests investors are pricing in the significant execution risk and potential for regulatory friction. The catalyst has moved the needle, but its ultimate impact hinges entirely on feasibility.

Performance Data and Valuation: The ETF Setup

The market has already priced in a powerful bullish narrative. The S&P 500 Aerospace & Defense Index has gained 53.52% over the past year, a surge that significantly outpaces the broader market's 16.15% rise. This momentum is not confined to the U.S. European defense stocks rallied 3.8% on Jan. 8, 2026, extending a weekly advance, while U.S. names like Lockheed Martin and Northrop Grumman have also seen strong moves following recent geopolitical actions. The setup is one of clear, global momentum.

Yet this strength comes with a valuation premium.

. The sector now trades at a forward P/E of 22.97X, a notable premium to the S&P 500's 18.58X. In other words, investors are paying up for the growth story. This creates a classic tension: the sector's performance reflects high expectations, but those expectations are now baked into the price.

The risk/reward here hinges on whether the catalysts can justify that premium. The geopolitical backdrop is undeniably supportive, with U.S. military operations in Venezuela and a $500 billion annual spending call reinforcing the long-term rearmament theme. However, the market's initial sell-off on the budget proposal shows it is also pricing in significant execution risk and potential regulatory friction. For an ETF investor, this means the sector's strong momentum may be vulnerable to any stumble in the political process or a slowdown in the promised spending surge. The valuation leaves little room for error.

Feasibility Check: The Debt and Tariff Reality

The political ambition is clear, but the fiscal math is shaky. The proposed $1.5 trillion defense budget for 2027 is not just a single-year spike; it represents a $5 trillion increase in defense spending through 2035. That scale would add a staggering $5.8 trillion to the national debt when interest is included. For context, the current U.S. national debt is already over $34 trillion. This isn't a minor adjustment; it's a fundamental shift in fiscal policy that would dramatically accelerate the debt trajectory.

The president's justification relies on tariff revenue, but the numbers don't add up. He argues tariffs will cover the cost, yet evidence shows the military spending increase would be about twice as large as expected tariff revenue. The Congressional Budget Office estimates tariffs could raise $2.5 trillion through 2035, or $3 trillion with interest. That covers only half the cost of the spending surge. In a worst-case scenario where the Supreme Court rules tariffs are illegal, the revenue available for deficit reduction would fall to roughly $700 billion through 2035, covering just 15% of the defense hike's cost. The funding plan is a house of cards.

This creates a major source of volatility. The entire political narrative for this spending surge is tied to the viability of these tariffs. Legal challenges to their authority, particularly under the International Emergency Economic Powers Act, are pending. A Supreme Court ruling against them would immediately undermine the proposed budget's financial foundation, turning a political promise into a fiscal impossibility. For investors, this is a key uncertainty that could trigger a sharp reassessment of the sector's long-term tailwind.

The bottom line is that the $1.5 trillion proposal is a powerful political signal, but its credibility as a sustainable, long-term driver is in serious doubt. The market's initial sell-off may have been an overreaction to the buyback executive order, but the underlying fiscal reality introduces a new layer of risk. This isn't a simple "more money for defense" story; it's a high-stakes gamble on the durability of a specific revenue stream. For tactical positioning, this uncertainty means the sector's momentum could face a significant headwind if the legal or fiscal foundation cracks.

Tactical ETF Watchlist and Entry Points

The event-driven setup now points to a specific tactical opportunity: a pullback following the initial negative reaction, with the key watchpoint being the Congressional budget process for FY2027. The market's sell-off on the buyback executive order created a potential entry point for investors who believe the long-term geopolitical tailwinds outweigh the near-term political friction.

For ETF exposure, two funds stand out based on their structure and the current catalyst. The WisdomTree Global Defense Fund (WDGF) offers a balanced, global approach. It allocates 54.51% of its weight to domestic defense stocks while maintaining exposure to 15 other countries. This is ideal for capturing the structural theme of increased defense spending across Europe, Asia, and the Middle East, as noted by industry observers. Its 0.60% expense ratio provides efficient access to this broad trend.

For more concentrated U.S. exposure, the iShares U.S. Aerospace & Defense ETF (ITA) is a direct play. It has already demonstrated its strength, gaining 55% over the past year versus the S&P 500's 17%. This ETF tracks the performance of the sector's largest domestic players, making it a pure bet on the U.S. rearmament narrative.

The tactical entry point hinges on the political process. The $1.5 trillion proposal is not law; it is a political signal that must navigate a stalled Congress. The initial sell-off suggests the market is pricing in execution risk. A sustained pullback, particularly if it follows a period of volatility around the Congressional budget hearings, would present a clearer entry for those betting on the sector's momentum and the long-term rearmament theme. The key watchpoint remains the feasibility of the funding plan, as legal challenges to the tariffs could quickly undermine the entire fiscal justification. For now, the setup favors patience and a focus on the ETFs that offer the best blend of global reach and U.S. concentration.