Trump's Military Spending Push and the Defense Sector Rally: Is Now the Time to Buy?

The U.S. defense sector has emerged as a focal point for investors in 2025, driven by President Donald Trump's ambitious $1.5 trillion 2027 defense budget proposal and a broader global defense spending supercycle according to CNBC. This surge in military spending, coupled with geopolitical tensions and technological advancements, has sparked a rally in defense stocks like Lockheed Martin, Raytheon, and Northrop Grumman. However, the sector's attractiveness is tempered by regulatory constraints, production challenges, and shifting capital flows. For investors, the question remains: Is now the time to buy into the defense sector, or are the risks outweighing the rewards?

Trump's "Dream Military" and Its Impact on Defense Stocks

President Trump's vision for a "Dream Military" has reshaped the defense landscape. His proposed 2027 budget-a 66% increase from the current $901 billion-has already driven pre-market gains for defense contractors. Yet, the plan includes stringent conditions: a ban on dividends and stock buybacks until companies accelerate production and modernize facilities, and a $5 million cap on executive pay. These measures aim to redirect capital toward operational efficiency but risk short-term volatility. For instance, shares of Northrop Grumman and Lockheed Martin initially surged on the budget announcement but later dipped when Trump highlighted production delays.

The sector's performance reflects this duality. While defense stocks returned 42.8% in 2025-outpacing the 25.2% gain in the tech sector-investors must weigh the long-term benefits of increased procurement against near-term regulatory pressures. Trump's emphasis on AI-driven capabilities and multidomain interoperability further underscores the sector's strategic importance, though adoption hurdles like regulatory uncertainty and legacy system integration remain significant.

Sector Rotation: Defense vs. Tech, Energy, and Healthcare

The defense sector's outperformance in 2025 aligns with broader sector rotation trends. As investors distanced themselves from overvalued tech stocks-particularly after Q1 volatility-capital flowed into defense and healthcare, which were perceived as more stable. The healthcare sector, for example, surged 14.5% year-to-date in Q4 2025, driven by biotech innovation. However, defense's 42.8% return highlights its unique appeal amid rising global tensions.

Energy, by contrast, delivered mixed results. While Q1 saw a 9.3% gain, the sector struggled in Q4 as oil prices fell 15% year-over-year according to analysis. This divergence underscores the appeal of defense as a hedge against geopolitical and economic uncertainties. For tactical allocators, the defense sector's resilience-bolstered by long-term contracts and a 6.8% annual growth rate in European defense budgets- makes it a compelling counterbalance to cyclical sectors like energy.

Risk/Reward Dynamics: A Double-Edged Sword

The defense sector's risk/reward profile is nuanced. On the upside, Trump's budget guarantees sustained demand for military equipment, AI systems, and logistics solutions. Deloitte notes that agentic AI is poised to scale in logistics and maintenance by 2026, offering a tailwind for firms with digital capabilities. Additionally, the sector's aftermarket-particularly engine MRO-provides stable cash flows, with global demand projected to grow at 3.2% annually.

However, risks persist. The sector's reliance on government contracts creates exposure to policy shifts, and Trump's executive pay caps could strain corporate balance sheets. Moreover, supply chain bottlenecks and skilled labor shortages threaten production timelines. For investors, the key is to prioritize firms with diversified portfolios and strong competitive advantages, such as Lockheed Martin's dominance in next-gen fighter jets or Raytheon's AI-driven command systems according to market analysis.

Tactical Allocation: ETFs and Strategic Exposure

For those seeking tactical exposure, defense ETFs like the Invesco Aerospace & Defense ETF (PPA) and the iShares U.S. Aerospace & Defense ETF (ITA) offer broad diversification. While specific inflow data for PPA, XHE, or XCI in 2025 is limited, thematic ETFs attracted $23 billion in inflows. Investors should also consider hedging with healthcare ETFs like the S&P 500 Health Care Select Sector SPDR Fund (XLV), which outperformed in Q4 2025.

Conclusion: A Strategic Buy, But With Caution

The defense sector's rally is well-founded, driven by Trump's spending push, AI adoption, and global tensions. However, investors must navigate regulatory headwinds and production challenges. For those with a medium-term horizon, defense stocks and ETFs offer a favorable risk/reward profile, particularly when paired with healthcare or energy allocations to balance sector-specific risks. As the 2026 election cycle unfolds, staying attuned to policy shifts and supply chain developments will be critical. Now may be the time to buy-but with a disciplined, diversified approach.