Navigating Geopolitical Crosswinds: European Utilities and Defense Stocks as Anchors of Resilience

The Eurozone's inflationary pressures have eased to a level that permits the European Central Bank (ECB) to adopt a dovish stance, offering a tailwind for sectors sensitive to monetary policy and geopolitical risks. With inflation dipping to 1.9% in May 2025—below the ECB's 2% target—and core inflation cooling, the bank has room to maintain accommodative policies. This environment creates a strategic opportunity in two sectors: utilities, which benefit from lower borrowing costs and energy transition tailwinds, and defense, fueled by NATO's increased spending amid geopolitical instability.

Utilities: Riding the Dual Waves of Low Rates and Energy Transition

The ECB's June 2025 decision to cut its key rates by 25 basis points—marking the first easing cycle since 2016—has reduced funding costs for utilities. This is critical for companies like Iberdrola (IBR.MC), which is aggressively expanding nuclear and renewable energy infrastructure. Lower rates enable cheaper debt financing for capital-intensive projects, such as its €30 billion investment plan through 2030.

Iberdrola's undervalued nuclear assets—key to grid stability and decarbonization—are poised to gain in a world where energy security is paramount. Meanwhile, core inflation's moderation (now at 2.3%) reduces the risk of regulatory overreach, allowing utilities to focus on long-term growth.

Defense: A Structural Growth Story Anchored in NATO's Spending Surge

Geopolitical tensions, particularly in Eastern Europe, have accelerated defense spending. NATO members are on track to meet their 2% GDP defense expenditure target, with countries like Germany and Poland prioritizing modernization. This benefits Rolls-Royce (RR.L), which supplies advanced propulsion systems for military aircraft and naval vessels.

The company's defense division, a steady 30% of revenue, is gaining traction as NATO allies seek to counter hybrid threats. Additionally, Rolls-Royce's exposure to nuclear submarine programs (e.g., the UK's Dreadnought class) provides a shield against macro volatility.

Why Allocate Now? A Confluence of Macro and Sectoral Tailwinds

1. ECB Policy Backstop: With inflation projected to average 2.0% in 2025 and 1.6% in 2026, the ECB's easing cycle is likely complete. This means lower rates for longer, boosting utilities' margins and enabling capital expenditures.
2. Defense as a “Recession-Resistant” Sector: Military budgets are less cyclical than other industries, and NATO's spending commitments are contractual, not discretionary.
3. Valuation Sweet Spots:
4. Iberdrola trades at 14.5x 2025E EPS, below its five-year average of 16.8x, despite record free cash flow.
5. Rolls-Royce's defense segment trades at 1.2x book value, undervalued relative to peers like Leonardo (LDO.MI) at 2.1x.

Risks to Consider

• Trade Tensions: Tariffs on defense components or energy equipment could disrupt supply chains.
• Inflation Volatility: A sudden spike (e.g., from energy price rebounds) might force the ECB to pause easing.

Investment Thesis

For investors seeking stability amid geopolitical and macroeconomic uncertainty, utilities and defense are the Eurozone's “defensive growth” sectors. Iberdrola and Rolls-Royce exemplify this duality:

• Iberdrola offers a 2.1% dividend yield with growth tied to regulatory-backed renewable targets and nuclear asset monetization.
• Rolls-Royce provides leverage to NATO's spending while its aero engine division recovers from pandemic lows, creating a dual-income stream.

Portfolio Strategy: Allocate 5-7% to European utilities and defense equities, with a preference for companies with:
1. Exposure to structural policies (e.g., Iberdrola's green subsidies).
2. Geographically diversified revenue streams (Rolls-Royce's global defense contracts).
3. Low sensitivity to trade wars (both companies derive <15% of revenue from China).

Conclusion

The ECB's pivot to easing, coupled with NATO's defense spending boom, has created a rare alignment of macro and sectoral dynamics. Utilities and defense are not just defensive plays—they are growth engines in an era of geopolitical fragmentation and energy transition. Investors who anchor their portfolios in these sectors today may find themselves well-positioned to weather crosswinds and capture the calmer seas of macro stability ahead.

Data as of June 19, 2025. Past performance is not indicative of future results. Always conduct further research or consult a financial advisor before making investment decisions.