Introduction
In an increasingly volatile geopolitical landscape, global defence markets are undergoing rapid and historic transformation. From the United States to Europe, military budgets are surging, procurement strategies are evolving, and investor interest is spiking. In the U.S., legacy defence giants are facing a wave of disruption from agile, venture-backed startups like Anduril and Palantir, the latter becoming a standout stock as investors bet on software’s growing role in modern warfare. The Pentagon’s shift toward innovation and diversified suppliers is challenging the dominance of traditional primes and redefining the future of defence contracting.
Meanwhile, across the pond, Europe is witnessing its own defence renaissance. The Russian invasion of Ukraine and the potential end of the Bretton Woods American pax era has acted as a wake-up call, catalyzing a continental push toward rearmament. Defence stocks like Rheinmetall and Leonardo have soared, backed by record order backlogs and rising government commitments. The recent announcement of the European Commission’s proposed €1.1 trillion spending plan — including a landmark Euro Defence Bond — underscores just how seriously the bloc is taking its strategic autonomy and long-term security.
Germany, in particular, is leading a historic fiscal shift to support this effort. Defence spending in excess of 1% of GDP will be exempt from constitutional borrowing restrictions, enabling expanded long-term investment. A new off-budget infrastructure fund will be authorized to borrow up to €500 billion over 12 years, with €100 billion allocated to the Climate and Transition Fund and another €100 billion distributed to Germany’s 16 states for regional development. Additionally, those states will gain the ability to borrow up to 0.35% of GDP — roughly €16 billion — rather than being bound by balanced budget rules. These measures mark a decisive structural break from Germany’s post-war fiscal conservatism and lay the groundwork for a sustained surge in defence and strategic infrastructure spending.
With defence budgets rising on both sides of the Atlantic and political consensus forming around military modernization, the global defence sector is entering a new era — one defined by urgency, innovation, and unprecedented investment.
Europe: An Overview
Growing geopolitical uncertainties and security concerns have recently fueled European defence stocks to soar to all-time highs, reflecting a profound shift towards rearmament across the continent. Since early 2022, triggered by the Russian invasion of Ukraine, the market capitalization of Europe’s top defence contractors has surged by roughly 60%, far outpacing their American counterparts, which saw gains of less than 40%. In particular, stocks like Rheinmetall AG (+65% YTD and +245% since Fall 2022) and Leonardo S.p.A. (+48% YTD and +139% since Fall 2022), Germany’s and Italy’s largest defence contractors, respectively, have experienced significant growth and an ever-growing order backlog.
The European defence sector portrays monopsonistic characteristics, as the primary customers are national governments. Therefore, the sector’s demand consists largely of national defence spending in the form of government contracts, creating significant supplier dependence on state funding. Luckily, throughout Europe, a structural shift in domestic policy and security strategies is taking place. Both Italy and Germany, as well as other countries, have signalled long-term commitments to military modernization, with Italy prioritizing defence spending despite high debt, and Germany planning to ease fiscal constraints to boost investment. Overall, European defence budgets are projected to grow at an annual rate of 6.1% from 2023 to 2035, significantly outpacing the United States (1.7%), Russia (3.2%), and China (3.1%).
Geopolitical Landscape
Ongoing conflicts act as the major catalysts for military investment throughout Europe. The Russian invasion of Ukraine prompted a fundamental shift in policies across the continent, creating a ripple effect throughout the defence industry. With the conflict in the Middle East erupting in late 2023, European defence stocks surged ~9% in a single week, while broader markets remained flat, as European governments, including Germany, France, and Italy, moved to replenish their ammunition and weapons reserves.
Out of all European countries, Germany — which deprioritized military spending post-WW2 — has led the movement of reshaping its defence strategy. In 2022, its parliament approved a historic €100 billion rearmament fund to “procure the necessary equipment for the Federal Armed Forces more quickly,” representing a major structural change in German policy. During the buildup to the general election, it has been evident that security is a major concern for the German public, as all major parties had pledged to meet or exceed the NATO spending target (2% of GDP). Furthermore, the coalition parties have agreed to exempt defence spending above 1% of GDP from the stringent debt rules, allowing the mobilization of large amounts of investment and representing a long-term demand pipeline for German defence companies.
Simultaneously, Italy has committed to increasing defence spending to 1.6% of GDP by 2027, indicative of a steadily increasing strategy. This is a strong indicator for future growth in the sector, as Italy is willing to increase spending even though government debt was 138.3% of the country’s nominal GDP in September 2024. Furthermore, in February 2025, Italy backed a European Commission proposal to exempt defence investments from EU deficit limits, which would provide long-term funding stability, accelerate domestic industry growth, and boost investor confidence.
Company Analysis – Rheinmetall AG
Historically, Rheinmetall operated as a balanced conglomerate with both defence and automotive interests, but recent geopolitical shifts — triggering an increase in European defence budgets — prompted a strategic realignment towards the military sector. For FY 2024, Rheinmetall illustrated impressive growth with consolidated sales growing by 36% to €9.75 billion, of which 80% can be attributed to the defence business. The company is also able to translate these sales into profits, showcasing earnings after taxes of €808 million (+38% YoY) and a 19% operating margin.
Similarly, Rheinmetall’s outlook for 2025 is favourable, with group sales expected to grow by 25–30%, largely attributed to the growing order backlog. At the end of FY 2024, the company reported an order backlog of €55 billion (+44%). This highlights the growing demand for defence equipment by European governments and acts as an indicator for increased domestic spending instead of funds flowing overseas.
However, a major problem for the company is recruiting skilled labor and finding production sites. As a result, Rheinmetall, as well as other defence companies such as Hensoldt, are exploiting the downsizing of the German car industry. With Volkswagen shutting down multiple domestic plants, leaving tens of thousands of skilled workers unemployed, the companies are hiring entire teams of engineers, ensuring a competent and productive workforce. Furthermore, Rheinmetall’s CEO has publicly announced that some Volkswagen production sites are suitable for producing tanks, marking a potential integration of the two industries and increasing output. In combination with the €8 billion already invested in increasing capacities (building plants, making acquisitions, and securing supply chains), the accelerated European defence spending and the growing security concerns lay the foundation for substantial growth over the coming years.
Company Analysis – Leonardo S.p.A
Leonardo S.p.A. is a critical player in the European defence industry, being best known for its role in military, aerospace, and security products. For FY 2024, the Rome-based company has reported revenues of €17.8 billion (+11%) and an EBITA of €1.5 billion (+12%), largely attributed to the solid performance of the defence & security business segments and the overcoming of supply chain issues. Similarly to Rheinmetall, the company has also recorded a record-breaking order backlog of €44 billion, which is equivalent to 2.5 years of production at current capacity. This ensures consistent future revenues and investment possibilities, and is largely driven by the increased European military spending.
Furthermore, to drive development and form a new “European nucleus” to produce military vehicles, Leonardo and Rheinmetall have launched a 50:50 joint venture called Leonardo Rheinmetall Military Vehicles (LRMV). Together, the two companies want to leverage their R&D to manufacture next-generation combat vehicles, including a new battle tank and armoured vehicles. With 60% of the work being located in Italy, the venture exemplifies a strategic commitment for both companies to their national industries, positioning LRMV as a key player in the European defence sector. The Italian government has already placed an order for 1,500 vehicles valued at €23 billion, marking a significant commitment to domestic defence production.
Leonardo’s shareholder structure emphasizes strong governmental influence, as Italy’s Ministry of Economy and Finance holds a 30.2% stake, highlighting the company’s importance in the country’s defence strategy. This is further underscored by the Italian government’s use of its “golden powers,” which allow control of foreign investment in strategic sectors such as defence. For example, in 2024, the government approved BlackRock to hold a stake exceeding 3% in Leonardo. This investment underscored market confidence and long-term growth both for the company and the wider European industry.
Trends in the European Market
As a result of conflicts around the globe and the growing uncertainty about American commitments to security, European military expenditures saw record growth in 2024, with budgets increasing by 11.7% in real terms. This increases Europe’s share of global defence spending, currently at 16%, to 21% by 2029, marking a clear move towards rearmament and modernization. A trend towards cross-border defence consortia — both between companies (e.g. LRMV) and between nations (e.g. the Future Combat Air System (FCAS) led by France, Germany, and Spain) — can be established. Europe needs to reduce its reliance on U.S. imports, thus increasing its strategic autonomy and mitigating the implications of a Trump presidency.
The significant growth in the defence market is strongly correlated with the evolution of NATO’s budget expectations. The 2% of GDP goal being declared a “floor, not a ceiling” in 2023 and discussions of raising the target to 3% are being overshadowed by Trump’s advocation of 5% of GDP. To put this into perspective, this would require a country like Germany to spend €230 billion yearly on defence, equivalent to 42% of its federal budget. Still, some European countries like Poland have already ramped up spending, being projected to reach 4.7% of GDP in 2025, setting a precedent for other nations. This underscores Europe’s trajectory towards higher defence budgets, fuelling growth in the defence sector by encouraging investment in local production capabilities, and reshaping the continent’s economic and industrial landscape.
Still, increasing defence budgets may not have the envisioned economic effect European leaders are looking for. Currently, 78% of defence procurement budgets in 2024 were spent on products from non-EU suppliers — 63% in the U.S. alone. This reduces the multiplier effect on Europe’s economy, as it limits domestic industry growth and job creation, thus reducing disposable income and investment. Goldman Sachs estimates that the fiscal multiplier on defence spending in Germany would be 0.5 over two years, meaning every €100 spent on the military would increase GDP by €50. Additionally, it is important to consider the origin of the funding, as tax increases or decreases in government spending in other areas could dampen economic growth. The most favourable method, both from a political and economic perspective, would be debt financing. In her “Rearm Europe Plan,” Ursula von der Leyen has proposed an EU-wide “Euro Defence Bond” which would raise €150 billion. This money can then be loaned to member states, allowing for collective borrowing for joint defence projects, providing stable long-term funding, and ensuring that funds go to EU-based projects, not abroad. Furthermore, allowing defence spending to be exempt from national expenditure would let deficits exceed the 3% limit by up to 1.5 percentage points, enabling up to €257 billion in additional annual defence spending — potentially totalling €650 billion over four years.
European Conclusion
In summary, the European defence sector is experiencing fundamental transformation, driven by increasing military budgets, changing NATO commitments, and growing security concerns. Despite the challenges of meeting rising demand, leading European companies like Rheinmetall and Leonardo are investing heavily in the market, looking to turn the historic spending into sustainable, long-term gains — which benefits both security and economic growth. Maximizing this impact will not only depend on how much is spent, but where and how it is allocated — making domestic procurement and strategic debt financing essential to ensure that defence investment translates into long-term growth, both in the defence industry and the broader European economy.
US: A Historical Overview, Cold War Contracting and Evolution of Procurement
In the early Cold War era (1950s), U.S. defence contracting was characterized by cost-plus contracts and a broad base of competing suppliers. The government often reimbursed contractors’ costs plus a fixed fee, encouraging rapid development of new weapons but sometimes leading to overruns. Procurement policy shifted away from open bidding toward tighter regulation in the 1950s, as officials believed controls would ensure quality and innovation. By the 1960s, however, the Pentagon renewed its push for competition — Defence Secretary Robert McNamara cited studies showing cost savings of ~25% when programs were competed rather than sole-sourced. Throughout the Cold War, dozens of defence firms vied for contracts across aerospace, electronics, shipbuilding, and more. Major players like Boeing [NYSE: BA], Lockheed, Northrop, Grumman, Hughes Aircraft, and McDonnell Douglas (among many others) often competed to design cutting-edge jets, missiles, and space systems.
The government’s procurement practices evolved through cycles of reform: high-profile cost overruns in the 1980s spurred the Competition in Contracting Act of 1984, which mandated “full and open competition” for most contracts and curbed sole-source deals. These shifts, along with periodic commission recommendations (e.g., the 1986 Packard Commission), gradually modernized defence acquisition. By the late 1980s, the U.S. defence industrial base was expansive, yet increasingly scrutinized for efficiency — setting the stage for the profound changes of the post-Cold War era.
Current Landscape of U.S. Defence Contracting: Consolidation, Big Five, and Innovation
Since the end of the Cold War, the U.S. defence sector has undergone dramatic consolidation. A pivotal moment came in 1993 at the so-called “Last Supper” dinner, when Pentagon leaders warned industry CEOs that reduced military budgets could not sustain all existing contractors. Within a decade, the number of large prime contractors plummeted from 51 to just 5 through mergers. Iconic companies like Hughes, McDonnell Douglas, and others were absorbed into today’s giants. The modern landscape is dominated by five prime contractors — Lockheed Martin [NYSE: LMT], Boeing, Northrop Grumman [NYSE: NOC], Raytheon Technologies [NYSE: RTX], and General Dynamics [NYSE: GD] — which together capture a major share of U.S. Department of Defence procurement. This consolidation has left many defence market segments with only one or a few suppliers. For example, 90% of U.S. missiles now come from just three sources, and categories like tactical aircraft have dwindled to essentially two or three prime manufacturers.
While consolidation improved efficiency in some areas, it also raised concerns about competition and innovation. With fewer rivals in each market, today’s big defence firms face limited incentives to radically out-innovate one another. Some experts argue that the resulting oligopoly has led to stagnation in high-tech innovation, as dominant primes focus on incremental upgrades over breakthroughs. Increased shareholder returns and a stable budget environment have reduced the urgency for unconventional R&D. Pentagon officials across administrations have raised alarms about the risks of limited competition. In response, the Department of Defence has made promoting competition a top priority — from scrutinizing mergers more strictly to encouraging new entrants — to avoid over-reliance on a handful of contractors. The current industrial strategy emphasizes generational investments to expand capacity and agility, especially given the recent strain on supply chains. These trends point to a defence base that may struggle to meet future needs without broadening its supplier pool and pushing for more innovation.
Emerging Defence Tech and Startups: Disruptive Players Reshaping the Industry
In recent years, a wave of venture-backed tech firms has begun reshaping U.S. defence innovation. Their agility and commercial mindset contrast with the slower processes of traditional primes.
- Palantir [NYSE: PLTR]: A pioneer in defence data analytics, Palantir challenged legacy IT systems by offering adaptable, off-the-shelf software. It eventually displaced traditional contractors in major intelligence system contracts. Its CTO, Shyam Sankar, in “The Defence Reformation,” calls for revitalizing defence procurement, highlighting how private-sector software companies can compete and win in defence contracting.
- Anduril: Founded in 2017 by Oculus co-founder Palmer Luckey, Anduril develops autonomous drones, AI surveillance, and battlefield management tools. It pushes high-speed innovation in areas like counter-drone warfare and virtual border security.
Silicon Valley’s traditional hesitation to engage in defence is fading. Firms in AI, hypersonics, cyber, and unmanned systems are now securing funding and Pentagon contracts. The Defence Innovation Unit and AFWERX are facilitating this integration by offering non-traditional paths into defence procurement. This movement represents a cultural and strategic shift, with the Department of Defence actively trying to leverage commercial tech innovation to diversify and accelerate its capabilities.
Implications for the Future: Toward a Hybrid Innovation Model
The rise of agile defence tech firms could reinvigorate competition and help reverse some downsides of past consolidation. A broader industrial base gives the Pentagon more options while introducing faster development cycles. This trend may push large primes to innovate more or collaborate with smaller firms, forming a hybrid model that combines scale with speed. However, challenges remain. Scaling from prototype to battlefield deployment still requires navigating complex military bureaucracy and ensuring long-term reliability — tasks where incumbents have the edge. If this hybrid model succeeds, the U.S. defence sector could strike a new balance between legacy experience and disruptive innovation, essential for maintaining its technological edge in an increasingly contested global environment.
Conclusion
As geopolitical tensions escalate and nations pivot toward self-reliance and strategic autonomy, defence is becoming a core theme for both stock pickers and macro investors. With rising nationalism, more conservative fiscal attitudes, and record-breaking spending plans across the West, the sector is no longer a niche play — it’s fast becoming a structural pillar of long-term investment strategy.
References
[1] Sayler, Kelley M., “The U.S. Defense Industry in a New Era”, 2023
[2] Parker, Tom, “Why Is the U.S. Defense Industrial Base So Isolated from the U.S. Economy?”, 2023
[3] Mehta, Aaron, “The Pentagon Wants Industry to Transform Again to Meet Demand. Can It?”, 2023
[4] Lord, Ellen M., “The Defense Reformation”, 2023
[5] Youssef, Nancy A., “Military-Tech Startups Vie for Billions as Hegseth Shakes Up Pentagon Spending”, 2023
[6] McLeary, Paul, “Tech Firms Want to Upend the Pentagon. The Old Defense Guard Has Some Lessons for Them”, 2023
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