A Closer Look at the Defense and Aerospace Industry

Author:

Radhika Narang
Investment Specialist, Client Consultant, Confluence

Growing Focus on Defense Sector

The defense and aerospace sector is generally more stable than other industries, as it is less affected by economic cycles. It also offers a diversified approach to portfolios while providing exposure to Large-cap companies with stable revenue. These stocks often increase in value due to geopolitical tensions and conflicts. In recent years, defense stocks have risen in response to the conflict and geopolitical tensions between Russia and Ukraine since 2022.

US and European Defense Spending

The current geopolitical situation in Ukraine is creating a strong demand for increased military spending across Europe. The United States contributes nearly 40% of global military spending and allocates a larger portion of its GDP to defense compared to most other countries. Although the US has contributed over $120 billion to Ukraine since the war with Russia began three years ago, that support is now declining with the change in administration. As the US reduces its involvement, Europe is stepping up to offer continued support to Ukraine in its fight against Russia, pledging further assistance. The rise in the European defense sector is fueled not only by the geopolitical situation surrounding Ukraine but also by a shift in European defense policy.

Performance of the Top 10 US and European Defense Stocks since 2022

Since the Russia-Ukraine conflict began, top U.S. and European defense stocks have been on divergent paths. The charts below show the performance of the top 10 defense stocks in the US and Europe since the onset of the Russia-Ukraine conflict. After a dip in October 2022, both regions saw a significant rebound in the defense sector's performance. While US defense stocks have remained resilient, Europe has experienced exponential growth, with a substantial spike beginning this year. This surge is largely driven by discussions around increased military spending amid concerns that US support for Ukraine may be tapering off.

Defense Stock Performance in the US and Europe Over the Past Year

U.S. defense giants like GE and the RTX Group have shown resilience over the past year. Demand for GE Aerospace's aftermarket services boosted in 2024, while many airlines, including Boeing, experienced production challenges, resulting in a performance surge of nearly 70% in 2024. However, the region's defense sector performance was largely dragged down by Boeing's underperformance, which returned -2.06%, significantly behind those of its European competitor, Airbus.

In Europe, the performance of companies Rolls-Royce Holdings and Rheinmetall has been noteworthy. Rolls-Royce has shown impressive financial growth in 2024, with results far surpassing market expectations. The company’s defense division has solidified its position through several major contract wins. Similarly, Rheinmetall's performance was largely driven by the increasing demand for defense-related products and services.

Style Factor Biases

Although the valuations of the top 10 defense stocks in both regions are relatively expensive, these stocks show a favorable momentum compared to their respective markets. Additionally, the European defense industry demonstrates a positive tilt towards Growth and Quality when compared to MSCI Europe.

The defense and aerospace sector continues to demonstrate resilience and strategic importance in a time of heightened geopolitical uncertainty. While U.S. defense spending remains dominant globally, a notable shift is underway as European nations ramp up their military commitments and defense budgets, partially in response to waning U.S. support for Ukraine. There may also be opportunities in adjacent European sectors like cybersecurity, logistics, and advanced manufacturing. This evolving landscape has catalyzed exceptional equity performance among top European defense companies, outpacing their U.S. counterparts in 2024.

Despite premium valuations, the sector benefits from strong momentum and quality growth characteristics, particularly in Europe. With growing investor interest and the potential for sustained policy support, the defense sector remains a compelling area for diversified portfolio exposure—particularly for those seeking stability, growth, and long-term strategic tailwinds.

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