European Defense Stocks in Focus

European defense stocks surged following renewed calls from U.S. officials for Europe to take greater responsibility for its own military spending. The demand for increased defense investment, coupled with heightened geopolitical tensions, has driven major European defense firms to near all-time highs. Simultaneously, rising government bond yields in Europe reflect investor expectations of higher fiscal outlays for military purposes. The latest rally underscores a broader shift in global defense policy and its impact on financial markets, particularly as Europe moves to bolster its security infrastructure amid uncertainty over continued U.S. support.

The pan-European Stoxx 600 index climbed to successive all-time highs, with the Aerospace and Defense sub-index rising 4.2% on Monday. Major European defense firms posted double-digit gains, including Germany’s Rheinmetall, which soared 14%, and Sweden’s Saab, which advanced 16%. The U.K.’s BAE Systems also saw a substantial rise of 9%, its largest one-day gain since July 2022. Italy’s Leonardo and France’s Thales posted increases of over 5%, while Thyssenkrupp gained nearly 20% on expectations that it will spin off its warship division, TKMS. These gains reflect heightened investor confidence that European governments will step up military expenditures, particularly as European leaders discuss raising NATO’s defense spending target beyond the current 2% of GDP threshold.

The shift in sentiment was further fueled by remarks from European officials at the Munich Security Conference, where European Commission President Ursula von der Leyen proposed exempting defense spending from EU fiscal limits. NATO Secretary-General Mark Rutte also signaled that military spending targets will be reassessed at the upcoming June summit, reinforcing expectations that European defense budgets are set to rise. This has prompted analysts at Morgan Stanley to reiterate their bullish outlook on the sector, identifying Rheinmetall, Leonardo, and BAE Systems as key beneficiaries of the spending surge. European defense firms are expected to see sustained demand for military hardware, including armored vehicles, air defense systems, and ammunition, as governments work to modernize their forces and build up stockpiles.

The policy shift comes amid increasing pressure from Washington, with President Donald Trump advocating for NATO members to raise their defense contributions to 5% of GDP. The possibility of reduced U.S. involvement in European security has led to urgent discussions among EU leaders on how to guarantee regional stability independently. The recent emergency summit in Paris underscored the need for greater European coordination on defense procurement, with proposals ranging from joint military initiatives to expanded security guarantees. European policymakers recognize that their influence in future peace negotiations regarding Ukraine is tied to their ability to provide substantial military support.

As European defense stocks surge, U.S. defense firms with European exposure are also well-positioned to benefit from increased spending. Lockheed Martin, which derived approximately 10.4% of its total sales from European customers in 2023, stands to gain from rising procurement budgets. RTX Corporation (formerly Raytheon Technologies) has a substantial European footprint, with 44% of its $93 billion defense backlog attributed to international clients, including European nations. Northrop Grumman and Boeing, while less transparent about their European revenue breakdowns, also maintain significant defense contracts in the region. Given the growing appetite for advanced military equipment, these firms are likely to see increased orders for missile defense systems, fighter jets, and surveillance technologies.

Investor enthusiasm for defense stocks has contributed to broader market gains, with European equities edging closer to record highs. The STOXX 600 index climbed 0.54% on Monday, continuing its streak of record closes, while Germany’s DAX remains near an all-time high despite slight losses. In the U.S., markets were closed for Presidents Day, but futures trading indicated a positive outlook, buoyed in part by expectations that defense spending will remain a key investment theme. Additionally, rising European bond yields—Germany’s 10-year yield reached 2.51%, while France’s hit 3.18%—suggest markets are pricing in higher government borrowing to fund military expenditures.

While the geopolitical landscape remains fluid, the outlook for defense stocks remains strong. European governments are increasingly committed to ramping up military spending, and with Brussels considering loosening fiscal constraints to facilitate this process, defense firms are expected to enjoy sustained demand. Meanwhile, U.S. defense contractors with European exposure stand to gain as NATO allies place larger orders for advanced weaponry. With heightened geopolitical risks and policy shifts in play, defense stocks are emerging as one of the most promising investment opportunities in the current market environment.