By Simon Constable
The West, along with its allies, is now growing its armories with munitions, tanks, and other war materiel. After decades of complacency from some countries, the spending surge could continue for the foreseeable future, experts say.
"The war continues to rage in Ukraine and is a serious concern," says Seth Jones, president of the Center for Strategic & International Studies' Defense and Security Department. "There will be a push for increased defense spending."
That will likely lift profits for defense contractors based in the countries -- primarily in the U.S. and Europe -- that are members of the North Atlantic Treaty Organization.
In anticipation of increased demand for military equipment, investors could consider investing in the $625 million Future of Defence exchange-traded fund (ticker: NATO.UK), which tracks a wide basket of defense stocks based in member countries of NATO. These include Thales, Leonardo, and Rheinmetall. The ETF has returned 34% for the year through Dec. 9.
An alternative is the iShares U.S. Aerospace & Defense ETF $(ITA)$, which tracks a bundle of defense stocks and aerospace companies. These include military contractors Northrop Grumman, L3Harris Technologies, and General Dynamics. The fund has returned 19% this year.
Global military spending reached $2.4 trillion last year, an inflation-adjusted increase of 6.8%, according to the Stockholm International Peace Research Institute. Of the total, the U.S. spent the most, with a total bill of $916 billion, up from $877 billion the year before.
The U.S. isn't the beginning and end of things. Russia's invasion of Ukraine jolted Europe from decades of complacency over defense. Many of Europe's largest countries haven't fulfilled their NATO obligation of spending 2% or more of their gross domestic product on defense for decades. Germany, Europe's largest economy, hasn't achieved that since 1992 and hadn't returned to the required level by the end of 2023, according to recent estimates. France and Spain have barely done any better.
Germany's chancellor recently pledged to increase military spending, and other countries are following suit. "In the context of Russia invading Ukraine, countries in Europe are preparing to up their spending to where it should have been for many years," says Nicolas Owens, an industrials analyst at Morningstar.
In the past, President-elect Donald Trump has threatened to encourage Russia to attack NATO member countries that don't fulfill their defense obligations.
While the U.S. defense budget isn't likely to grow more than a few percent this coming year, it doesn't mean there will be a collapse in overall defense revenue, says Greg Konrad, senior vice president of equity research at Jefferies. There is a big need to restock munitions such as rocket motors, chips, and artillery shells, he points out. These items, many of which were shipped to Ukraine and Israel over the past two to three years, can only get used once, unlike tanks or planes. They need to be replaced.
Around two-thirds of all armaments purchased by Europe come from the U.S., but European defense companies will also continue producing materiel. "Everyone is looking at how they can strengthen their defense, " Konrad says. "Part of that push has been a focus on much more domestic defense contracting in Europe."
While the likelihood is that military spending will be a sustained phenomenon, there are risks. European politics may derail defense budgets, as many countries are fiscally stretched. Peace may prevail in Ukraine, the Middle East, and between China and Taiwan. But given the state of the world, it looks like a good bet.
Email: editors@barrons.com
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December 11, 2024 01:30 ET (06:30 GMT)
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