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, and OCBC says Asian defence stocks are still in the early phases of a structural upcycle with scope for re-rating. The Bloomberg Asia Pacific Aerospace & Defence Index is up ~48% over five years versus +106% for the Dow Jones U.S. Defence Index and +243% for MSCI Europe A&D; the Asian gauge trades at 46.7x forward 12-month earnings versus its 10-year average of 44.2x (MSCI ACWI A&D at 34.9x, ~1.3 SD above long-term avg). OCBC highlights country budget increases — China +7% for 2026, South Korea +7.5% to 65.9 trillion won, Japan seeking a record ¥9 trillion — and recommends exposure to drones, cybersecurity and materials.

Analysis

The strategic pivot to onshore production creates a multi-year capital cycle that favors system integrators, test-and-measure suppliers, and domestic semiconductor/cloud infra providers over pure-play weapons OEMs. Expect lumpy contract awards that front-load capex (fab, composites, robotics) in years 1–3 and recurring software/cyber services thereafter; that cadence amplifies revenue growth volatility but extends gross margins for firms that capture recurring maintenance and software licensing.

Second-order winners will include firms that provide AI compute, edge inference hardware, and secure communications — not just traditional defence primes. Tight GPU/specialized accelerator supply and export-control risk mean compute demand may translate into outsized orderbooks for flexible OEMs that can reconfigure server SKUs and source alternatives, creating a 6–18 month window of premium pricing for modular server makers.

Key tail risks are policy reversals (de-escalation or procurement freezes), export-control shock that severs access to Western semiconductors, and foreign-exchange-driven cost escalation for locally produced but imported-input assemblies. Near-term catalysts to watch: multi-year procurement framework announcements (months), large system integration awards (quarters), and GPU inventory cycles (0–6 months); any reversal in these can compress multiples quickly, especially for names priced for growth.

Key Decisions for Investors

• Long SMCI (core equity + 6–12 month call spread): buy SMCI equity size 1.5–2% NAV and overlay a 6–12 month call spread to cap cost. Rationale: capture defense/A.I. server demand during onshoring capex cycle. Target +35–50% in 6–12 months; stop-loss 15%. Risk: GPU supply disruption or export controls could halve upside.
• Long UBS call calendar (3m/9m): buy 3-month ATM calls and sell 9-month calls to monetize near-term conviction on continued risk-on flows into US equity markets that lift bank trading/AUM. Position size 1% NAV; expected payoff 2:1 if S&P momentum continues. Tail risk: sudden risk-off or regulatory headline; delta-hedge weekly.
• Paired trade — long selective Asian defence small-mid caps / short overvalued global prime ETF (6–24 months): finance long via short of large-cap primes to express structural onshoring while hedging macro beta. Aim for 1.5:1 gross exposure (long:short). Profit if regional suppliers re-rate; risk if broad de-risking hits both legs.
• Protective hedge — buy 9–12 month puts on SMCI or a semiconductor/compute basket sized to cover 30–50% of SMCI position: use this to guard against abrupt export-control or GPU-availability shocks. Cost is insurance for the core long; acceptable to pay up to 3–4% NAV for comprehensive coverage over 12 months.