European defense stocks surged on Monday as regional leaders committed to taking on “the heavy lifting” of defending Ukraine from Russia, amid tensions following a recent conflict between President Volodymyr Zelensky of Ukraine and President Trump.
European defense stocks soar as leaders pledge to support Ukraine
Shares of major European defense companies—including British contractor BAE Systems, German manufacturer Rheinmetall, and Italian firm Leonardo—reached record highs on Monday. The rally helped elevate the Stoxx Europe 600 index, traditionally dominated by luxury stocks, to new levels.
Despite investor enthusiasm, concerns remain about Europe’s ability to increase military spending, given high debt levels, slow growth, and potential tariffs from Trump. British Prime Minister Keir Starmer announced a four-point plan at a summit with European leaders, which includes creating an Anglo-French “coalition of the willing” to defend Ukraine, potentially involving “boots on the ground and planes in the air.” Additionally, Britain has provided £2.26 billion ($2.86 billion) in loans to support Ukraine’s military.
Credit agencies had previously warned about the financial implications of increasing NATO members’ military spending to 3 percent of GDP, which is still short of Trump’s desired 5 percent. Such spending increases could necessitate unpopular cuts to social safety nets, according to Fitch Ratings. Other strategies to finance this spending might include loosening fiscal rules, reallocating unspent pandemic recovery funds, or raising taxes.
Yields on European bonds rose on Monday, highlighting concerns among investors regarding increased public spending at a time when the economy is slowing. Analysts are divided over the impact of defense spending commitments on the European Central Bank’s upcoming interest rate decisions.
Market conditions are critical, as failure to adequately support Ukraine risks forcing European nations into unfavorable agreements with Russia, further straining European unity. Holger Schmieding of Berenberg noted, “Trump, Putin (and possibly Elon Musk?) all seem to dislike the European Union,” expressing a preference for negotiations with individual countries instead of the EU bloc.
The rush to boost military funding has sharply increased defense stock valuations, with shares from companies such as BAE Systems and Rheinmetall experiencing volatility. On Monday, several defense stocks briefly increased 20-30%, surprising fund managers. The sector has seen more than a doubling of value since the onset of the war in Ukraine, leading many defense stocks to trade at record-high multiples, sometimes surpassing those of American counterparts.
Investors now speculate that European governments might increase defense spending to a permanent 3% of GDP, aided by potential easing of EU fiscal rules. Countries like Italy and Spain continue to lag below the current NATO spending target of 2%. German leadership may modify its “debt brake,” which limits borrowing, paving the way for a significant infusion into a €100 billion fund established for defense spending in Germany.
Recent advancements prompted investment banks to revise their profit projections upward, justifying expected increases in defense spending. However, caution has begun to enter the minds of some fund managers. Rory Dowie, a portfolio manager, expressed a need to assess the sustainability of increased defense spending, particularly if a resolution arises in the Russia-Ukraine conflict under Trump’s administration.
The STOXX Aerospace and Defense index saw a new record high before slightly declining on Tuesday. As of 1553 GMT, it was down 1.5%, holding a market capitalization of $514 million and having surged roughly 170% since the invasion of Ukraine.
According to Nordea’s senior strategist Hertta Alava, aggressive buying of defense ETFs contributed to the rally, but the high valuations raise the possibility of a pullback. Nonetheless, defense remains an appealing sector, as it is one of the few growth areas in Europe. Rheinmetall trades at 36 times expected earnings, the highest on record since the late 1980s. Other companies in the sector, such as Saab, Thales, and Leonardo, exhibit similarly elevated earnings multiples.
In the United States, China, and Asia, competing companies are also seeing significant stock increases. Rheinmetall has surged over 80% this year, reaching a record €1,144.50 on Monday, compared to less than €100 before the conflict in Ukraine began. Hanwha Aerospace and its shipbuilding unit Hanwha Ocean have also seen shares rally substantially, contributing to an impressive overall increase in defense-related investments across the Pacific.
Global defense stocks now appear expensive, with firms like Hanwha Ocean trading at 52 times forward earnings, and Rheinmetall at 37 times. Yet, optimism persists due to expected security spending increases, as indicated by the European Union’s plan to extend €150 billion ($158 billion) in loans for defense improvements. Germany is set to create a €500 billion fund for crucial defense investments, emphasizing the multilateral response to ongoing threats.
Featured image credit: Christian Lue/Unsplash
