Geopolitical Risk and Political Instability in U.S. Defense Policy: Assessing the Impact of Legislative-Military Tensions on Defense Sector Investment Opportunities

The U.S. defense sector has long been a barometer for geopolitical risk, but the past three years have seen unprecedented turbulence. Legislative-military tensions-driven by fiscal constraints, policy disputes, and global instability-have reshaped investment dynamics in ways that demand a nuanced understanding. From the fiscal year 2023 to 2025, the interplay between congressional gridlock and military modernization needs has created a volatile yet potentially lucrative landscape for investors.

Legislative-Military Tensions: A Double-Edged Sword

The U.S. Department of Defense (DOD) has operated under a series of continuing resolutions (CRs) since 2023, delaying full-year appropriations and creating uncertainty for defense contractors. By March 2025, the DOD faced another CR expiration, with the risk of a government shutdown looming until December 20, 2024 according to CSIS analysis. These CRs, while preventing immediate shutdowns, have restricted the DOD's ability to initiate new programs or scale production, stifling innovation in critical areas like AI-driven warfare and drone systems.

Compounding this, the Fiscal Responsibility Act (FRA) of 2023 imposed a $895 billion cap on 2025 defense funding-a 1% real-term cut from 2024 levels according to CSIS analysis. If sequestration triggers by April 30, 2025, the sector could face a $45 billion reduction, further complicating long-term planning for companies like Agile Defense and Cubic Defense. Such fiscal constraints have forced investors to weigh short-term volatility against long-term demand, particularly as global defense spending hit $2.718 trillion in 2024.

Market Reactions: ETFs, Stocks, and Strategic Shifts

The defense sector's resilience has been evident in its financial performance. The SPADE Defense Index surged 90% from the start of the Russia-Ukraine conflict through mid-2025, outpacing the U.S. stock market's 40% growth. European defense-focused ETFs, such as those tracking Rheinmetall and other firms, have attracted $15 billion in assets, reflecting a broader shift toward regional self-reliance.

However, U.S. investors have faced a mixed bag. While defense ETFs like the SPDR S&P Aerospace & Defense ETF (XAR) and iShares U.S. Aerospace & Defense ETF (ITA) dipped in early November 2025, their underlying fundamentals remain robust. For example, Carpenter Technology (CRS), a key supplier of high-performance alloys, saw institutional investors like Cetera Investment Advisers increase stakes by 19.7% in 2025. Conversely, Vanguard Group reduced its position in CRS by 6.9%, signaling cautious optimism amid policy uncertainties.

Corporate Adaptations: Innovation Amid Uncertainty

Defense contractors have responded to legislative headwinds with strategic pivots. Cubic Defense, for instance, has prioritized encrypted training systems like the P5 Block 7 Update, which supports secure Live-Virtual-Constructive (LVC) training for joint operations. These innovations align with the DOD's push for multi-domain readiness, even as funding delays persist.

Meanwhile, companies like Agile Defense have leveraged contract awards to navigate fiscal uncertainty. Agile's integration of IntelliBridge in 2025 marked a new phase of growth, underscoring the sector's adaptability. Similarly, Carpenter Technology's $700 million private offering of senior notes in 2025 highlights how firms are restructuring capital to hedge against sequestration risks.

Investment Strategies: Navigating the New Normal

For investors, the key lies in balancing risk and reward. While CRs and sequestration risks create short-term volatility, the long-term outlook remains bullish. European defense spending, bolstered by mechanisms like the EU's €150 billion SAFE fund, is projected to grow faster than U.S. budgets. This shift opens opportunities in land-based systems, naval advancements, and AI-driven logistics-sectors where U.S. firms like Cubic Defense and European counterparts like Rheinmetall are already gaining traction according to Morningstar analysis.

Moreover, defense ETFs offer diversified exposure to this growth. Despite recent dips, funds like XAR and ITA remain attractive for long-term investors, given their alignment with global defense spending trends. However, investors should remain vigilant about fiscal cliff scenarios, particularly if the FRA's sequestration triggers materialize.

Conclusion: A Sector at the Crossroads

The U.S. defense sector stands at a crossroads, shaped by legislative-military tensions and geopolitical upheaval. While CRs and sequestration risks introduce near-term headwinds, the sector's underlying strength-driven by technological innovation and global demand-positions it for sustained growth. For investors, the challenge is to navigate this complexity with a focus on resilience, diversification, and strategic foresight.