DEFENCE: Geopolitical risks have returned. With the first anniversary of the Ukraine invasion, Russia withdrawing from the START nuclear deal, and Chinese balloons over the US. Defence stocks have strongly outperformed swooning stock markets in the last year. And their valuations now trade at a 20-30% premium to market. But these gains likely remain well supported. Global defence spending is now structurally rising at over double the pre-2021 3% rates. With room for more as sluggish government arms procurement gradually cranks up, especially in Europe. Whilst the industry is benefitting from the cost cuts and consolidation of the recent leaner times.
STOCKS: US defence stocks, proxied by the ITA ETF, have outpaced the S&P 500 index by over 20 points the past year. This was led by heavyweights Raytheon (RTX), Lockheed Martin (LMT), and Transdigm (TDG). And even with the commercial aircraft led underperformance of Boeing (BA). European defence stocks have also outperformed and their valuations re-rated. From local champions Rheinmetall (RHM.DE) to Dassault (DSY.PA), Leonardo (LDO.MI), and BAE (BA.L). They are beneficiaries of the long-awaited catch up in European defence spending.
CONTEXT: World defence spending has fallen by a proportional 60% since its cold war highs (see chart) and averaged 2.2% of global GDP, or $2.1 billion, in 2021. The US is by far the largest defence spender, with its $800 billion budget equal to 3.5% of its GDP. This is followed by China’s near $300 billion of spending, though equal to only 1.7% of GDP. Russia is the fifth largest global spender, equal to 4.0% its economy. Europe was a laggard, spending only 1.5% of GDP and below the oft-spoken 2% target. The Arab world leads regional spend at 4.6% GDP.
All data, figures & charts are valid as of 22/02/2023