Are Defense Stocks Overvalued Despite Rising Tensions in 2026?

The defense sector has long been a refuge for investors seeking stability amid geopolitical uncertainty. However, as 2026 unfolds, the question of whether defense stocks are overvalued-despite a backdrop of escalating global tensions and a historic $1.5 trillion defense budget proposal-has become increasingly urgent. With key players like Lockheed Martin (LMT), Raytheon Technologies (RTX), and Northrop Grumman (NOC) trading at premium valuations, the interplay between geopolitical tailwinds and valuation risks demands a nuanced analysis.

Valuation Metrics: A Sector Trading at Premiums

The U.S. Aerospace & Defense Industry currently trades at a P/E ratio of 44.8x, significantly above its 3-year average of 32.1x. This surge reflects investor optimism about sustained demand, driven by geopolitical instability and legislative actions such as the National Defense Authorization Act (NDAA). For individual firms, the picture is mixed: LMT's P/E of 27.27 appears relatively conservative compared to RTX's 37.87, while NOC's financial health suggests it remains a critical player despite unlisted metrics according to analysis. Market caps have also expanded, with LMT at $115 billion, RTX at $249 billion, and NOC at $84.9 billion as of 2025, supported by forward P/E ratios of 21.9x, 28.9x, and 22.9x, respectively. These valuations are further bolstered by high P/B ratios, reflecting the sector's role in long-term government contracts and technological dominance in areas like missile systems and nuclear deterrence.

Geopolitical Tailwinds: A Perfect Storm of Demand

The Trump administration's proposed 2027 defense budget-a 66% increase to $1.5 trillion-has been a catalyst for the sector's rally. This surge in spending, coupled with the NDAA's focus on modernizing military capabilities, has driven European defense stocks like BAE Systems and Rheinmetall to record highs, while U.S. firms such as LMT and NOC gained 7.9% and 8.3%, respectively according to Reuters. Geopolitical tensions, including conflicts in Ukraine, the Middle East, and the Western Hemisphere, have further entrenched defense spending as a priority. The NDAA's emphasis on procurement for the Army, Navy, and Air Force-alongside multiyear munitions contracts-underscores the sector's structural tailwinds.

However, the sector's growth is not solely driven by military demand. The 2026 NDAA has integrated national security into broader technology governance, influencing AI, cybersecurity, and supply chain resilience. This convergence of enterprise risk and defense strategy has expanded the sector's appeal to investors seeking exposure to reindustrialization and domestic infrastructure projects as White Case notes.

Valuation Risks: A Bubble in the Making?

Despite these tailwinds, skepticism persists. Defense stocks now trade at enterprise value-to-sales ratios nearly triple those of the early 21st century. Critics argue that such valuations assume perpetual geopolitical instability and unyielding defense budgets-a scenario that may not materialize. For instance, the NDAA's mixed record on weapons programs-such as canceling the Navy's Constellation-class frigate while underfunding the F/A-XX fighter- highlights the tension between congressional intent and strategic outcomes. Additionally, the sector's reliance on government contracts exposes it to policy shifts, such as potential cuts if tensions ease or fiscal discipline returns.

The risks are compounded by broader macroeconomic concerns. A report by the Stimson Center warns of a potential financial crisis driven by overvalued AI-driven assets, which could erode confidence in defense stocks if the economy falters according to their analysis. Moreover, the U.S. dollar's weakening position and the country's retreat from global hegemony may limit its ability to sustain high defense spending as the report notes.

Balancing the Equation: A Cautious Outlook

The defense sector's valuation premium is justified by its role in a world increasingly defined by conflict and technological competition. Yet, investors must weigh these tailwinds against the risks of overvaluation. While the Trump administration's budget and NDAA reforms provide near-term support, long-term sustainability depends on whether geopolitical tensions persist and whether defense budgets can absorb multi-trillion-dollar increases without triggering inflationary pressures or fiscal strain.

For now, the sector's growth appears anchored in its critical role in global rearmament. However, as one analyst notes, "The question is not whether defense stocks are overvalued, but whether the world is underprepared for the conflicts that justify these valuations" according to Yahoo Finance. In this context, a diversified approach-balancing exposure to defense giants with hedging against macroeconomic risks-may offer the most prudent path forward.