New world order: Security spending enters a super cycle

The world is rearming. Heightened global geopolitical tensions and shifting US defense priorities mean other nations must do more individually to ensure they meet their own security needs. As a result, we expect greater global defense spending for years to come.

We have already seen European and Asian leaders increase their focus on developing deeper domestic defense capabilities to confront these new geopolitical realities. And US defense spending is likely to further rise to meet new policy objectives, including a greater focus on domestic security and on the Western Hemisphere.

As US spending climbs, other countries may feel added pressure to further harden their own security. We see potential investment prospects in areas where strategic priorities and production capacity intersect with capital deployment opportunities.  

Europe: Early days of a major spending cycle

For Europe and Asia, greater defense spending has taken on a new urgency. War in Ukraine, fractures within NATO, tensions in the Middle East and the potential for conflict between China and Taiwan all mean that individual countries that previously relied on the US defense umbrella must now more actively consider their own defense postures.

In Europe, spending on new arms and weapons systems is already rising. Led by Germany, European defense spending is going to surge over the next decade, reaching nearly US$700 billion, according to one estimate from investment bank Barclays.¹ Europe not only needs to invest in new domestically made systems, focusing on air defense and long-range strike capabilities as well as intelligence gathering, among other programs, but must also continue to replenish arms sent to Ukraine.

And if the 27 European Union (EU) countries are to meet the 3.5% of gross domestic product (GDP) NATO spending target, the bloc would need to spend more than €630 billion (US$746 billion) a year compared with an estimated €381 billion in 2025, according to the European Defence Agency.² (See Exhibit 1.) We are optimistic that given the urgency European countries face to become more self-reliant, defense spending can climb to—and remain at­­—a much higher level beyond the 2030 time frame.

The constant budgetary tension between higher defense spending and Europe’s social spending will likely continue, but we see signs that greater military spending may have more political support, given increased global tensions. However, local politics, economic conditions and the desire to maintain social programs could constrain some European governments from meeting the 3.5% target.

Nonetheless, a massive amount of new spending should be coming even if Europe struggles to meet the loftier goals. We could see increased knock-on economic gains as necessary infrastructure is upgraded to support the military buildup. Germany, for one, is spending significantly on infrastructure alongside its more robust defense budget. (See Exhibit 2.)

As a result, we could see value industries—from cement and asphalt firms to rail and rail signaling equipment companies—benefit as countries upgrade roads, bridges and railways to allow for the easier movement of troops and equipment, potentially leading to faster longer-term economic growth.

Asia: Beefing up defenses

A similar trend is expected in Asia, where a new Japanese government and escalating tensions with China have made greater defense spending a priority. While Japan is currently revising its security policy, it has been budgeting much more for defense, including cruise missiles and unmanned defensive capabilities, to counter perceived risks.

Elsewhere, Australian and South Korean defense spending is set to grow in the mid-single digits in 2026, according to government data, amid increasing risks in the Indo-Pacific region and potentially decreased US involvement. This further rise comes after a steady increase in regional spending in recent years. (See Exhibit 3.) As regional defense spending climbs, domestic arms manufacturers, including the Japanese conglomerates and the big South Korean defense equipment makers, could see growing orders.

United States: New priorities, more spending

Meanwhile, the apparent US pullback from global alliances has put a greater security burden on Europe and Asia but does not preclude increased US defense spending over the longer term. For the US administration to meet the policy objectives laid out in its recent National Security Strategy, including reasserting itself in the Western Hemisphere and putting resources into a missile defense shield at home, US defense spending should continue to rise, in our view.

The United States already spends significantly more on defense than its European allies. (See Exhibit 4.) The recently proposed US$1.5 trillion defense budget is nearly double estimated 2025 levels, an indication that spending will rise. For what and by how much remains unclear.

We expect policy priorities to center on increased missile and munition production, solid rocket motors for missiles, greater shipbuilding, and space initiatives. In our view, efforts to expand the US defense industrial base are also positive for smaller defense contractors, not just for the big, prime players.

While the extent of US defense spending remains uncertain, we believe that even if the Democrats win the House of Representatives in the November midterm elections this year, many programs have enough political support to receive funding. And any uplift in US spending may put added pressure on European and Asian countries to further ramp up their own outlays.

Finding value in a stronger defense

Certainly, many global defense stocks have rallied over the past year. But we continue to see opportunities, particularly in European defense firms, as the region invests in its own capabilities over the longer term. Efforts to create a common EU defense funding solution and expectations that defense budgets could rise significantly over the next five years could further bolster procurement and earnings at European defense companies.

Major US defense company shares have already seen a solid run, making current US opportunities more limited, in our view. Still, US spending initiatives and the benefits many contractors will see in the medium term from the step-up in European orders for missiles, aircraft, ships, drones and other equipment can create openings for investment. Noise around US budget negotiations and the upcoming mid-term elections could create short-term pressure on major US defense companies, which may create opportunities to pick up shares at more attractive valuation multiples.

The race to rearm is creating a potential global defense super cycle, but keep an eye on stock valuations after the latest run.