Defence stocks: more room to go?

How much can defence stocks be expected to rise because of the current turmoil? Will there be another global arms race?

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The war business is booming

Following the Russian invasion of Ukraine Lockheed Martin's shares are trading up over 16%. But that stock isn't the most dramatic. Germany has committed to double its defence budget this year. After that, Rheinmetall's stock jumped 62.2% above its pre-war price but has since fallen back a little.

It's natural to expect a bump in the stock price at the start of a war. But, the question is whether those gains will be maintained and will the stock price go higher. Has the market overpriced the potential move towards increased defence spending in its shock over the sudden invasion of Ukraine? And what happens if a peace deal is worked out relatively soon?

Who are the big spenders?

Now there is a significant conflict in which the US is not the protagonist, although the US is the most critical contributor to NATO. But the alliance isn't a direct participant. The US has also been insisting on other countries raising their military spending, and it appears that could finally be happening. So far, the Biden Administration has not indicated it is looking into increase spending for next year's budget.

This means we are likely looking towards European defence companies as the primary beneficiaries of increased concern over the geopolitical situation. With Russia bogged down in a war and facing severe sanctions, it's not so much a "race," but more like European countries "catching up" with other global powers.

Who are the players?

Of course, US defence firms could see additional contracts. For example, Poland is beefing up its Patriot missile defence system, which Raytheon supplies. The vaunted Iron Dome, which relies on Raytheon's technology, has increased interest in Europe.

Europe's defence economy is considerably underdeveloped, meaning that some firms can see substantial growth. However, the evolution of the conflict in Ukraine suggests that standard Cold War military doctrine might be outdated, and the focus could move away from more expensive major equipment like fighters and submarines towards agility and flexibility in a land conflict.

Thus, firms like Thales, Rheinmetall, Mercedes, and Saab could have better potential than traditional and the best-known defence firms.

Defence stocks outperformance

While war in Ukraine has sent the broader markets lower, defence stocks have offered the best defence for portfolios.

Source: Reuters / Refinitiv

The top 10 holdings of the SPDR S&P 500 Aerospace and Defence ETF are:

Source: ssga.com

Key takeaways

Most defence stocks have already had their run so entering positions now risks buying from the early investors who are taking profits.

Whether there is more room to go in this trade will hinge on other European countries ramping up defense spending and of course how the war in Ukraine develops.