Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 590

The mispriced investment opportunity in global defence

For most of the last four decades, investors have enjoyed a giant convergence trade.

It was a convergence of economic policy direction, which led to a convergence of generally lower inflation and interest rates—generating higher trend economic growth rates—primarily through increasingly free-wheeling globalisation and free trade.

The trigger for this benign cycle was a generalised geopolitical view that the Cold War was over for good, and most could benefit. We did not question the long-term sustainability of this wonderland, because we believed that economic growth could appease even longstanding ethnic/territorial resentments.

A key driver of the ensuing lack of interest in defence has been the widespread belief that globalisation’s benefits, via contributions to prosperity and economic growth, had succeeded in establishing a new paradigm whereby war was unnecessary, and states could simply focus on economic development.

The reversal

The abrupt reversal of the ‘peace dividend’ – most notably in Europe amid Russia’s war on Ukraine – and the deployment of new military technologies like drones and electronic signal jamming has fueled a rapid acceleration of investment in defence.

These investments range from the upgrading of hardware through the modernisation of equipment, the updating of training to absorb the lessons of Ukraine and Gaza, the recalibration of financing and supply chains, and investments to rapidly increase domestic production capacity.

The commitment by European NATO members to invest over US$400 billion annually[1] for at least the next decade is just the start, as the recent growth in the number of private equity and public markets mandates suggests.

Unprecedented spending, again…

Defence spending in 2023 reached its ninth successive annual record, totaling US$2.4 trillion.[2] This amount represents a 36% increase over the last decade.

Over the next six years, NATO spending alone is estimated at US$8.9 trillion, of which US$3.2 trillion is from European NATO members and Canada.[3] It works out to be around US$500 billion a year, rising to US$600 billion a year in 2029.

We believe these developments have reopened an investment opportunity in the defence sector.

A much-changed industry

The last time a defence stock was among the top 10 performers of the S&P 500 Index was in the 1980s. The global defence industry has changed a lot since then.

In the 1980s, there were estimated to be more than 3,000 companies in what was known as the “military-industrial complex”. Tenders often received hundreds of proposals.

Today the sector has consolidated, with contracts tiered by specialisation as well as by geography. There are very few companies that can supply high-ticket, high-specification hardware.

Exhibit 1: The United States and China dominate arms production

Source: Top 100 | Defence News, News about defence programs, business, and technology. Defence News. As of 2023.

Yet there is also a plethora of companies providing newer defence capabilities, and the investment universe provided by the ‘new look’ defence sector is significant.

This ranges from very large companies like Microsoft, which provides cutting-edge defence capabilities against cyberattacks, to small companies like QinetiQ[4], which provide military robots, risk evaluation across air, land and sea, and cybersecurity solutions.

The obvious and not-so-obvious winners

The obvious winners from this fast-growing spend on defence equipment are the usual suspects—the large, established players with strong balance sheets and stronger relationships with their buyers around the globe.

There is also a less-appreciated universe of French, Italian, German and South Korean producers who are gaining market share, particularly with buyers in Europe and southeast Asia.

European manufacturers, for example, will take market share from Russia over the next decades, as India’s gradual modernisation gathers pace and the managed decline in dependence on Russian arms accelerates.

Furthermore, Japanese companies have been banned from exporting weapons since the mid-1960s under the “Three Principles on Arms Exports” policy.[5] This ban is now under revision, with a potential reversal on the cards, which would open up lucrative new markets for Japanese defence companies.

Potential mispricing

The investment case in defence is built on concrete evidence of plans for capital expenditure and research and development programs in a wide variety of subsectors. Three elements of the investment case appear to be mispriced:

1. The magnitude of the public and private sector capital expenditure in defence.

Many countries are still in the process of reviewing their defence architecture in the light of lessons learned in Ukraine and the Middle East.

This process will result in a new set of priorities and requirements to suit modern asymmetric warfare, across multiple domains. It seems prudent to assume that the amount of capital investment will be significantly higher than currently expected.

2. The longevity of this investment theme seems underappreciated.

The combination of changes in capabilities that militaries now require to defend their countries is enormous in scale and in reach, which implies a decades long runway.

3. The wide range of opportunities for investors.

As the template defence structure changes, so does the definition of the defence industry.

The range covers both the traditional (non-proscribed armaments) and the exciting new technologies (LEO Satellite mapping/communications, AI enhanced data management programs, etc.). Much of this will doubtless be transferred to civilian applications.

Finally, there is a group of companies in a variety of geographies (South Korea, India and Japan) that stand to benefit from this investment theme.

 


[1] Source: “Defense Expenditure of NATO Countries.” NATO, 2014-2024. June 17, 2024.
[2] Source: The Stockholm International Peace Research Institute. The SIPRI Yearbook 2024.
[3] Sources: IMF, NATO, Franklin Templeton Institute calculations. (IMF GDP projections and NATO members’ statements on future defense spending as % of GDP). There is no assurance that any estimate, forecast or projection will be realised,
[4] QinetiQ evaluates, integrates and secures mission critical platforms, systems, information and assets.
[5] Source: “Japan’s Security Policy.” Ministry of Foreign Affairs of Japan, Japan’s Security Policy. December 5, 2023.

 

Kim Catechis is an Investment Strategist with the Franklin Templeton Institute. Franklin Templeton is a sponsor of Firstlinks. This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.

For more articles and papers from Franklin Templeton and specialist investment managers, please click here.

This article is an abridged extract from Franklin Templeton’s recent white paper “Deep waves: The paradoxical trinity of defense.” Go here to read the full version and important disclaimers.

 

RELATED ARTICLES

Slowing global trade not the threat investors fear

banner

Most viewed in recent weeks

Australian stocks will crush housing over the next decade, one year on

Last year, I wrote an article suggesting returns from ASX stocks would trample those from housing over the next decade. One year later, this is an update on how that forecast is going and what's changed since.

What to expect from the Australian property market in 2025

The housing market was subdued in 2024, and pessimism abounds as we start the new year. 2025 is likely to be a tale of two halves, with interest rate cuts fuelling a resurgence in buyer demand in the second half of the year.

Howard Marks warns of market froth

The renowned investor has penned his first investor letter for 2025 and it’s a ripper. He runs through what bubbles are, which ones he’s experienced, and whether today’s markets qualify as the third major bubble of this century.

9 lessons from 2024

Key lessons include expensive stocks can always get more expensive, Bitcoin is our tulip mania, follow the smart money, the young are coming with pitchforks on housing, and the importance of staying invested.

The 20 most popular articles of 2024

Check out the most-read Firstlinks articles from 2024. From '16 ASX stocks to buy and hold forever', to 'The best strategy to build income for life', and 'Where baby boomer wealth will end up', there's something for all.

2025: Another bullish year ahead for equities?

2024 was a banner year for equities, with a run-up in US tech stocks broadening into a global market rally, and the big question now is whether the good times can continue? History suggests optimism is warranted.

Latest Updates

Investment strategies

The perfect portfolio for the next decade

This examines the performance of key asset classes and sub-sectors in 2024 and over longer timeframes, and the lessons that can be drawn for constructing an investment portfolio for the next decade.

Shares

The case for and against US stock market exceptionalism

The outlook for equities in 2025 has been dominated by one question: will the US market's supremacy continue? Whichever side of the debate you sit on, you should challenge yourself by considering the alternative.

Taxation

Negative gearing: is it a tax concession?

Negative gearing allows investors to deduct rental property expenses, including interest, from taxable income, but its tax concession status is debatable. The real issue lies in the favorable tax treatment of capital gains. 

Investing

How can you not be bullish the US?

Trump's election has turbocharged US equities, but can that outperformance continue? Expensive valuations, rising bond yields, and a potential narrowing of EPS growth versus the rest of the world, are risks.

Planning

Navigating broken relationships and untangling assets

Untangling assets after a broken relationship can be daunting. But approaching the situation fully informed, in good health and with open communication can make the process more manageable and less costly.

Beware the bond vigilantes in Australia

Unlike their peers in the US and UK, policy makers in Australia haven't faced a bond market rebellion in recent times. This could change if current levels of issuance at the state and territory level continue.

Retirement

What you need to know about retirement village contracts

Retirement village contracts often require significant upfront payments, with residents losing control over their money. While they may offer a '100% share in capital gain', it's important to look at the numbers before committing.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.