Asian defence stocks in early stage of upcycle as spending rises: OCBC

Asia defence spending rose 5.7% in real terms to $573 billion in 2025; China raised its 2026 defence budget by 7%, South Korea lifted spending 7.5% to 65.9 trillion won, and Japan is targeting a record ¥9 trillion budget. The Bloomberg Asia Pacific Aerospace & Defence Index is up ~48% over five years and currently trades at 46.7x forward 12-month earnings (10-year avg 44.2x), while OCBC says Asian defence stocks are likely in the early stages of an upcycle with room to rerate. OCBC recommends exposure to companies tied to drones, cybersecurity and materials as governments accelerate domestic procurement and manufacturing.

Analysis

Asia’s shift toward onshore defence supply creates a multi-year demand stream that disproportionately benefits firms selling long‑lead, hard‑to‑substitute inputs (specialty alloys, RF semiconductors, rare‑earth separation) and tier‑2 contract manufacturers that win multi‑year build contracts. Order books that are fixed‑price or indexed to specific input baskets will compress volatility in prime contractors’ margins while expanding margins for niche suppliers with scarce capacity, creating asymmetric returns for upstream names over 12–36 months.

A second‑order re‑rating will come from the intersection of industrial policy and export control fragmentation: non‑Chinese suppliers that can offer guaranteed export‑compliant supply chains will command multiple expansion versus peers, forcing primes to re‑source and accelerate M&A of regional specialists. That dynamic also amplifies cyclical capital intensity — expect longer working capital tails, rising WIP financing needs and higher demand for contract manufacturing capacity, which will benefit private equity and specialty lenders to the sector.

Key downside levers are secular: a rapid de‑escalation diplomatic path or near‑term fiscal tightening in major Asian economies would remove the political imperative for rearmament and compress forward cash flows, while higher real interest rates raise discount rates for long, lumpy contracts and could delay capex starts. Practical catalysts to watch in the next 3–18 months are large procurement awards, regional export‑control announcements, rare‑earth pricing inflection points, and sovereign budget cycles that convert intent into signed contracts.

Key Decisions for Investors

• Overweight select primes via asymmetric options: buy 12–18 month call spreads on RTX and LMT (e.g., buy 12–18mo ITM call / sell further OTM call) to capture re‑rating around multi‑year contracts while capping premium outlay. Target payoff: 25–40% upside if procurement cycle accelerates; max loss = premium paid (~100%).
• Buy cybersecurity leaders (CRWD or PANW) on a 6–12 month horizon—these act as durable revenue plays as defence budgets expand into cyber. Implement via buy-and-write (purchase stock, sell 3–6 month slightly OTM calls) to generate yield; reward: 20–35% total return if government contracting accelerates, risk: ~15–25% drawdown if multiples compress.
• Take material/critical‑component exposure with MP Materials (MP) or comparable rare‑earth/advanced‑materials names for 12–24 months. Use equity or long‑dated calls; pair with a broad miner short (e.g., long MP / short BHP) to isolate rare‑earth tightening. Upside scenario +40% on supply diversification, downside -25% if commodity demand softens.
• Event pair: long selected Asian tier‑2 contractors (idiosyncratic names via local listings/active manager exposure) vs short export‑sensitive Taiwanese tech hardware names for 6–12 months to capture re‑allocation of local content. Size small (5–8% net) and monitor tender announcements; hedge with 3–6 month puts on the long leg ahead of budget decisions to limit downside.