European Equities: A Strategic Bet in a Post-Trump Trade-War Era

In the aftermath of the Trump-era trade wars, global investors are recalibrating their portfolios to navigate a world of heightened geopolitical risk and shifting economic alliances. Nowhere is this recalibration more evident than in the European defense sector, where a rare convergence of retail enthusiasm and institutional validation is fueling a powerful long-term growth story. With defense spending surging, valuations looking attractive, and policy tailwinds accelerating industrial modernization, European equities are emerging as a compelling diversification play for investors seeking resilience and upside in uncertain times.

The Catalyst: Defense Spending and Strategic Autonomy

The EU's Readiness 2030 initiative and the €800 billion ReArm Europe Plan have ignited a structural shift in European defense spending. By 2028, member states aim to allocate 1.5% of GDP annually to defense, a move driven by the urgent need for strategic autonomy amid U.S. foreign policy shifts and global instability. This spending surge is not just about military readiness—it's about economic stimulus. Macroeconomic models suggest that a 1.5% GDP defense boost could lift real GDP by 0.5% by 2028, though risks like rising government debt (projected to increase by 2 percentage points) and import dependence linger.

The defense industry, however, is adapting. Companies like Rheinmetall (RHM) and Leonardo (LDO) are expanding into autonomous systems, AI-driven battlefield tech, and cyber defense, while the EU's Security Action for Europe (SAFE) loan instrument is unlocking private capital to reduce fragmentation. This industrial modernization is creating a virtuous cycle: higher R&D and infrastructure spending amplify economic returns, and policy support ensures long-term demand.

Retail and Institutional Momentum: A Perfect Storm

The surge in European defense stocks has captured the imagination of both retail and institutional investors. Retail traders, once fixated on U.S. meme stocks, are now flocking to European equities, drawn by the sector's undervaluation and geopolitical tailwinds. For example, Rheinmetall has more than doubled in 2025, with retail investors like Paul De Santis and Lia Holmgren betting on its expansion into digital defense solutions. Meanwhile, institutional money is flowing into the S&P Europe Defense Vision UCITS ETF (Acc), which tracks the S&P Europe Defense Vision Index and includes blue-chips like Rolls-Royce (RR) and BAE Systems (BA/).

This alignment is no accident. European defense stocks trade at a 15x forward P/E, compared to the S&P 500's 20x, while offering a 3.1% dividend yield versus the U.S. benchmark's 1.4%. These metrics, combined with strong revenue growth (e.g., 16.9% turnover growth in 2023 for the European defense industry), make the sector a value-rich play.

The Strategic Sectors: Aerospace, Cyber, and Industrial Capacity

Investors are focusing on three key areas within the European defense landscape:
1. Aerospace and Electronics: Companies like Airbus (EADSF) and Leonardo are leading in next-gen military aircraft and satellite surveillance.
2. Cyber and AI: Firms such as Thales (HO) and Diehl Defence are capitalizing on the shift toward digital warfare and AI-driven decision-making.
3. Industrial Capacity: The EU's push to localize semiconductor and rare earth production is boosting demand for firms with supply chain expertise.

For example, Rolls-Royce is benefiting from its nuclear submarine contracts with the Royal Navy, while BAE Systems is expanding its U.S. footprint to hedge against tariffs. These strategic moves are attracting both capital and confidence.

Risks and Realities

No investment is without risk. European defense stocks face challenges, including:
- Valuation Concerns: Some analysts, like Stephen Yiu, warn that the sector's gains may have already priced in future growth.
- Trade Tensions: The 15% U.S. tariff on EU imports, while manageable for defense firms, could ripple into other industries.
- Fragmentation: The EU's 170+ weapons systems versus the U.S.'s 30 remain a drag on efficiency.

However, these risks are outweighed by the sector's long-term fundamentals. European defense spending is projected to rise to 3.2% of GDP by 2030, and the EU's partnership with U.S. firms on projects like hypersonic weapons ensures continued relevance in global supply chains.

The Verdict: A Strategic Bet for Resilience

European equities, particularly defense stocks, offer a rare mix of undervaluation, policy-driven growth, and geopolitical resilience. For investors seeking diversification away from overpriced U.S. tech stocks, the continent's rearmament and industrial transformation present a compelling case.

Action Steps for Investors:
1. Allocate to ETFs: The S&P Europe Defense Vision UCITS ETF provides broad exposure to the sector's leaders.
2. Pick Individual Stocks: Focus on firms with strong R&D pipelines and strategic U.S. partnerships, such as Rheinmetall and Rolls-Royce.
3. Monitor Valuation Metrics: Keep an eye on P/E ratios and dividend sustainability as the sector matures.

In a world where uncertainty is the new normal, European defense stocks are not just a bet on war—they're a bet on the future of global power and the industries that will shape it. For those with a long-term horizon, the time to act is now.