LIVE MARKETS-U.S. defense stocks 'under-appreciated'

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U.S. DEFENSE STOCKS 'UNDER-APPRECIATED'

European defense stocks may have outperformed their U.S. counterparts so far this year, but analysts say the real opportunity lies in the U.S. market, where long-term growth and valuations look more compelling.

Year-to-date, the pan-European STOXX 600's aerospace & defense index .SXPARO has surged 52% compared to the U.S. equivalent S&P 500's .SPLRCAERO 30.5% gain.

"The discount that the defense names are trading relative to the S&P 500 is actually pretty attractive," said Morgan Stanley's head of aerospace & defense equity research Kristine Liwag.

"The U.S. names have lagged and you will probably see at least high single digit to low double digit CAGR in revenue in the next few years."

Several factors explain the divergence. Morningstar's chief EMEA equity market strategist Michael Field points to the relatively unloved status of Europe's defense stocks prior to the Russia-Ukraine war as well as the boost from rising NATO spending targets.

NATO countries have pledged to spend 5% of GDP on defense over the next decade. For the European Union, that would mean nearly tripling last year’s defense outlay of €325 billion ($377 billion) to over €900 billion.

Field also highlights a key structural difference: "U.S. defense stocks are centered around the U.S. government spending."

That’s where analysts like Liwag and Richard Safran, aerospace and defense managing director at Seaport Research Partners, believe the market hasn’t fully priced in the upside.

"We're in year one or two of a 10-year spending cycle," Seaport Research's Safran said. "Valuation is still under-appreciated. The peak of the cycle is likely 7 to 8 years away, and we're looking at something rather substantial.”

The U.S. 2026 fiscal-year budget allocates $893 billion to defense spending, separate from the additional $150 billion package in the 'big beautiful bill.'

Safran sees this trend as sustainable, noting that defense spending typically moves in 20-year cycles, with modernization as a key focus.

Liwag believes the sector to be undervalued and names Northrop Grumman NOC and RTX RTX as her top picks.

"If you pick the portfolio that is most aligned to U.S. defense priorities, you could see an attractive sector," she said.

While European defense stocks might remain appealing, U.S. firms still dominate the technology that global allies rely on.

"You'll hear threats like 'We're not going to buy from the U.S.,' but the reality is (Europe) can't fulfill their needs domestically," said Safran. "They'll still buy American — just not look like they're buying American."

(Twesha Dikshit)

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