Geopolitical Risk as a Catalyst: Defense and Energy Sectors Lead the Charge in a Volatile Market

The global markets of 2025 are defined by a paradox: while the FTSE 100 has surged 12.4% year-to-date, outperforming the S&P 500 and the Dow, it remains a barometer of geopolitical fragility. The index's gains are not a product of economic euphoria but a response to the persistent shadow of conflict, particularly the Ukraine-Russia war, which has reshaped defense budgets, energy policies, and investor behavior. For those who understand the interplay between risk and resilience, the defense and energy sectors—two of the FTSE 100's most influential components—offer a compelling case for overweighting in a world where volatility is the new normal.

The Defense Sector: A New Era of Strategic Spending

The Ukraine-Russia conflict has ignited a global arms race, with defense budgets expanding at Cold War-era rates. The U.S. allocated $886 billion to defense in 2025, while Germany's spending jumped to $71.2 billion, and Russia's defense budget swelled to $145 billion—a 25% increase from 2024. These figures are not just numbers; they represent a structural shift in how nations prioritize security. The FTSE 100's defense-heavy constituents, such as BAE Systems and Rolls-Royce, have benefited from this tailwind. BAE, for instance, has seen its shares rise 18% in 2025, driven by contracts for advanced radar systems and armored vehicles.

The strategic case for defense stocks is further reinforced by the U.S. and NATO's commitment to maintaining a credible deterrent. The U.S. has used its Presidential Drawdown Authority 55 times since 2022 to send $45.8 billion in military equipment to Ukraine, while NATO members have pledged to raise defense spending to 5% of GDP. This spending spree is not a short-term spike but a multi-year trend, with global defense expenditures projected to grow at 8.13% CAGR through 2035. For investors, defense stocks are no longer cyclical plays—they are a hedge against a world where peace is increasingly fragile.

Energy: The Unseen Frontline of Geopolitical Risk

While defense spending grabs headlines, the energy sector is the silent battleground of the Ukraine-Russia conflict. Europe's REPowerEU Plan, aimed at ending Russian energy dependence by 2027, has accelerated investments in oil, gas, and renewables. The FTSE 100's energy majors—BP, Shell, and TotalEnergies—have thrived in this environment. Shell's $3.5 billion share buyback program in Q3 2024 and BP's $2.3 billion in operating cash flow underscore the sector's resilience. These companies are not just beneficiaries of higher oil prices; they are positioned to capitalize on the long-term energy transition, which includes hydrogen infrastructure and carbon capture technologies.

The strategic value of energy stocks lies in their dual role as both a hedge and a growth engine. As global demand for energy remains robust—driven by U.S. inflationary pressures and China's industrial rebound—energy companies offer high dividend yields and cash flow stability. For example, Shell's forward P/E of 8.7 and a dividend yield of 5.2% make it an attractive income play in a low-yield world. Meanwhile, the sector's exposure to geopolitical bottlenecks—such as the Red Sea shipping crisis and OPEC+ production cuts—ensures that volatility will persist, creating opportunities for contrarian investors.

The FTSE 100: A Proxy for Global Risk Appetite

The FTSE 100's performance in 2025 is a masterclass in sectoral divergence. While the index has outperformed U.S. benchmarks, its gains are heavily skewed toward defense and energy. These sectors account for over 25% of the index's weight, compared to just 5% for technology. This imbalance is not a weakness but a feature of the FTSE 100's DNA: it is a portfolio of multinational, yield-driven companies that thrive in a high-risk, low-growth environment.

The index's muted performance in tech and consumer discretionary sectors highlights its unique positioning. Unlike the S&P 500, which is dominated by growth stocks, the FTSE 100 is a value-oriented index with a focus on global commodities and financials. This structure makes it less sensitive to domestic UK policy shifts—such as the Bank of England's rate cuts—and more aligned with global macro trends. For investors seeking to hedge against U.S. dollar volatility and policy uncertainty, the FTSE 100 offers a compelling alternative.

Investment Implications: Overweight Defense and Energy

The strategic case for overweighting defense and energy sectors is clear. Defense stocks offer exposure to a secular spending boom, while energy plays provide a buffer against inflation and geopolitical shocks. The FTSE 100's sectoral composition makes it an ideal vehicle for this strategy, with its energy and defense components outperforming the broader market by a wide margin.

However, investors must remain cautious. The FTSE 100's low exposure to technology and its reliance on global commodity prices mean it is not a diversified portfolio. To mitigate this, investors should pair FTSE 100 exposure with high-quality tech stocks or gold, which can offset the index's cyclical risks. Additionally, the potential for a U.S. rate cut in Q4 2025 could boost growth sectors, creating a divergence between the FTSE 100 and U.S. indices.

In conclusion, the Ukraine-Russia conflict has transformed defense and energy into essential hedging tools. For investors navigating a world of geopolitical uncertainty, the FTSE 100's sectoral strengths offer a roadmap to resilience. As the global economy grapples with the aftershocks of war and energy transition, those who align their portfolios with the new realities of risk will be best positioned to thrive.