U.S. Defense Sector Soars on Iran Tensions: XAR ETF as a Tactical Play for Geopolitical Risk

As geopolitical tensions with Iran escalate, the U.S. defense sector is emerging as a key beneficiary of heightened global instability. With military conflicts and diplomatic standoffs dominating headlines, investors are turning to defense stocks to capitalize on a “geopolitical risk premium.” Among the vehicles gaining traction is the SPDR® S&P Aerospace & Defense ETF (XAR), which offers a tactical, diversified play on this theme. Here's why the sector—and this ETF—deserve attention.

Geopolitical Risks Driving Defense Spending

The U.S. military budget has surged to $997 billion in 2024, accounting for 37% of global defense spending, and is projected to climb further in 2026. This growth is being fueled by escalating tensions with Iran, Russia, and China, as well as a broader push for self-reliance in defense infrastructure. For instance, recent U.S. airstrikes in Syria targeting Iranian-backed groups, coupled with ongoing negotiations over the Iran nuclear deal, have underscored the sector's relevance.

Analysts estimate that every 1% increase in geopolitical risk raises defense spending by approximately 0.5%, as governments prioritize preparedness. This dynamic has already translated into strong earnings for defense contractors like Lockheed Martin and Northrop Grumman, which reported robust backlogs and record orders in early 2025.

How XAR Captures the Opportunity

The SPDR® S&P Aerospace & Defense ETF (XAR) is uniquely positioned to benefit from these trends. Unlike traditional sector funds, XAR employs a modified equal-weighted index strategy, avoiding overexposure to large-cap giants like Boeing while maintaining broad diversification. As of June 2025, its top holdings include:

• Archer Aviation Inc (4.97%): A leader in electric vertical takeoff and landing (eVTOL) aircraft, which could redefine military logistics.
• AeroVironment Inc (4.96%): A specialist in small drones used for reconnaissance and combat, directly serving U.S. military needs.
• Kratos Defense + Security (4.41%): A provider of advanced drone systems and electronic warfare solutions.

This mix balances exposure to traditional defense contractors and emerging aerospace innovators, making XAR a comprehensive tool for capturing both near-term geopolitical tailwinds and long-term tech-driven growth.

Performance and Valuation

XAR has delivered exceptional returns, outperforming broader markets and peers. Over the past year, it gained 36.09%, handily beating the S&P 500's 16% rise. Its low expense ratio of 0.35% further enhances its cost efficiency compared to peers like the iShares U.S. Aerospace & Defense ETF (ITA), which charges 0.40%.

Valuation metrics are mixed but contextually favorable. XAR's P/E ratio of 23.24 is above the sector average but aligns with its growth-oriented portfolio. Meanwhile, its dividend yield of 0.57% prioritizes capital appreciation over income—a trade-off acceptable given the sector's growth trajectory.

Risks to Consider

No investment is without risks. The defense sector faces headwinds such as:
- Political uncertainty: Defense budgets could shrink under a new administration or fiscal austerity measures.
- Supply chain challenges: Tariffs on aluminum and trade disputes have already impacted companies like Boeing.
- Geopolitical volatility: While risks drive spending, a sudden de-escalation of tensions could reduce urgency.

Tactical Allocation Strategy

For investors seeking to capitalize on geopolitical risk premiums, XAR offers a compelling entry point. Consider a 5–10% allocation to the ETF as part of a diversified portfolio. Pair it with broader equity exposure to balance sector-specific risks.

Conclusion

The U.S. defense sector is a key beneficiary of today's volatile geopolitical landscape. The SPDR® S&P Aerospace & Defense ETF (XAR) stands out as a tactical vehicle to access this theme, combining low costs, diversified exposure, and a focus on companies at the forefront of innovation. As tensions with Iran and other adversaries persist, investors may find XAR a strategic hedge against uncertainty—and a play on the next wave of defense spending.