Russia's latest attacks provide fresh impetus for European defense stocks

Renewed Russian attacks on Ukraine have further boosted European defense stocks, with the Select Stocks Europe Aerospace and Defense ETF rallying two-thirds in 2025. Increased defense spending plans and the upcoming NATO summit in The Hague are expected to maintain positive sentiment, while European defense chiefs estimate Russia could be ready to attack NATO as early as 2029, driving initiatives to accumulate ammunition stockpiles. The European Council's adoption of the SAFE instrument and JPMorgan's note highlighting the sector's rally reflect a shift towards joined-up strategic thinking, though questions remain regarding the long-term commitment of European nations to rapidly increase military spending.

Analysis

Renewed and intensified Russian aerial attacks on Ukraine have provided a significant catalyst for the European defense sector, with the Select Stocks Europe Aerospace and Defense ETF (EUAD) surging by two-thirds in 2025. This rally is underpinned by concrete plans for increased defense spending across European nations and anticipation of further commitments at the upcoming NATO summit in The Hague. European defense chiefs are preparing for prolonged hostilities, with Germany's defense chief, Carsten Breuer, mandating full armament by 2029, focusing on air defense, deep precision strike weapons, and electronic-warfare capabilities, amid estimates that Russia could be poised to attack NATO as early as that year. Consequently, twelve-month forward P/E multiples for the sector have expanded by approximately 40% this year, reaching a 100% premium to the Stoxx Euro 600 index, according to BofA research. Companies like Rheinmetall AG are illustrative, with expectations of high 20s organic revenue growth between 2024 and 2028, a stark contrast to mid-single-digit growth from 2016 to 2019, reflecting the market's rerating based on the perceived sustainability of top-line growth due to the extended conflict outlook. Further bolstering this bullish thesis, the European Council has adopted the SAFE instrument (Security Action for Europe) to facilitate joint military investment and procurement. JPMorgan highlighted a 20% rally for the European defense sector in May alone and 115% for the year, attributing this to joined-up strategic thinking. NATO Secretary-General Mark Rutte aims for members to commit 3.5% of GDP to defense and an additional 1.5% to defense-adjacent infrastructure. While historical lethargy and national debt issues might raise questions about the pace of European military buildup, current market sentiment appears largely undeterred, driven by the unabating Russian aggression. EUAD's significant holdings include Airbus SE, Safran S.A., Rheinmetall, BAE Systems PLC, and Rolls-Royce Holdings PLC.

Key Decisions for Investors

• Consider maintaining or initiating exposure to the European defense sector via instruments like EUAD or select individual stocks, given the strong tailwinds from heightened geopolitical risk and committed governmental spending increases.
• Evaluate the significantly expanded valuations, with forward P/E multiples now at a substantial premium, to ensure that robust growth expectations, such as Rheinmetall's projected high 20s revenue growth, are adequately reflected in current share prices and align with risk tolerance.
• Closely monitor the outcomes of the upcoming NATO summit, particularly regarding member commitments to the proposed 3.5% GDP defense spending target, and track the practical implementation of joint procurement initiatives like the SAFE instrument, as these will be critical for sustaining the sector's growth trajectory.
• For targeted investments, analyze companies like Rheinmetall, Airbus, Safran, BAE Systems, and Rolls-Royce, focusing on their alignment with priority defense capabilities such as air defense and precision strike systems, while also considering individual execution capabilities and financial health.