During his campaign, President-elect Trump said he would pull back on U.S. security relationships with Europe. And during a NATO summit in his first term, he threatened to leave the military alliance if allies didn’t boost spending.
European countries have boosted their defense spending since then, boosting the share prices of European defense companies. But much more is needed, since the President-elect is likely to follow through on his comments.
European Defense Spending to Double
European countries may need to double defense spending to meet the challenge of Russia’s aggression in Ukraine, as well as the possibility of less American support in a second Trump presidency, according to a Bloomberg Intelligence report.
The 15 largest European members of the North Atlantic Treaty Organization (NATO) might have to ramp up military investment by as much as $340 billion annually to $720 billion!
The extra spending would go toward battle tanks, artillery pieces and infantry fighting vehicles for ground forces, as well as support aircraft such as tankers, cargo and sub-hunters, the report says.
Here’s a key point - after decades of under-investment, stretching back to the end of the Cold War, rearmament at this scale could take more than a decade!
This is great news for European defense companies, whose backlog has already swelled.
In 2023, the European defense sector’s revenues grew by 17% from the previous year to about $165 billion, according to a report published recently by the Aerospace, Security and Defense Industries Association of Europe.
NATO’s European members continue to increase their spending. This year, 23 of 32 members are expected to meet or exceed the 2% of GDP target. Together, European NATO members and Canada will spend a combined 2.02% of GDP on defense, up from 1.43% a decade ago.
What Comes Next
Some are worried that if President Trump ends the Ukraine war quickly, it will hurt European defense stocks. While there may be a blip downward, it would only be a bit of profit-taking.
Shares in Germany's Rheinmetall AG (RNMBY), Sweden's Saab (SAABY), and Italy's Leonardo S.P.A (FINMY) have risen between 230% and 360% since Russia invaded its smaller neighbor in 2022. France's Thales (THLLY) and the UK's BAE Systems PLC (BAESY) are up 70 and 100%, respectively over the same period.
The reason for the gains goes beyond Trump or Russia.
When it comes to defense, Europe is following Trump’s example of “America First” with a “Europe First” policy.
Europe wants more defense spending kept at home. And the infrastructure is in place to do so.
In March, the bloc penned its first European defense industrial strategy. The aim is to reverse overseas spending: 78% of EU countries’ defense orders from February 2022 to June 2023 went to companies outside of Europe.
The EU is also on the verge of appointing its first defense commissioner, Andrius Kubilius. The former Lithuanian prime minister said recently that he wanted to create “a true single market for defense.”
Germany’s defense minister, Boris Pistorius, spoke of “what these times require,” referencing a new industrial imperative that's set to reshape Europe’s defense sector.
Buy EUAD
However, despite recently increased spending on armaments, Europe has decades of under-investment in security to address. Over the past 30 years, it has spent a cumulative $1.4 trillion less than required to meet NATO criteria, according to estimates from Berenberg Capital Markets. This year’s $23 billion overspend, relative to the target, doesn’t come close to making up that deficit.
That suggests a huge program of rearmament in Europe that will buoy spending even without the Ukraine war. That will translate to the overall trend for European defense stocks to remain up for the foreseeable future, thanks to this continued structural growth path.
These defense contractors are minting money. For example, the increased defense spending this year sent Rheinmetall’s sales up 39% year on year to €2.45 billion ($2.55 billion) in the third quarter. Full-year guidance is for €10 billion ($10.42 billion) of sales on a 15% operating margin.
Finally, there is large potential for more investor inflows into the sector as well. Morgan Stanley's investor positioning data shows that 72% of global funds have zero exposure to the European defense sector.
Fortunately for U.S. investors, there was a recent launch - on Oct. 22 - of an ETF from Tuttle Capital Management that gives investors an easy way to play the broad European defense sector. It is the Select STOXX Europe Aerospace & Defense ETF (EUAD).
The fund is based on the STOXX Europe Total Market Aerospace & Defense index, which is up 37.61% over the past year and 31.46% year-to-date. The fund expense ratio is 0.50%.
Matthew Tuttle, CEO of Tuttle Capital Management, said in a news release that “given the global state of tensions, and the possibility that the U.S. may pull back from European security commitments, we think there could be an investment edge in these names.”
I agree. The fund looks interesting - EUAD is a buy anywhere below $25.
