Senior PM explains why certain names are rising, how advisors can play the theme, and what ethical issues may arise for some clients
Europe is rearming. As the United States appears to pull back from its military commitments to Ukraine and question its role in NATO, European nations have shown willingness to fill the void. European Commission President Ursula von der Leyen has presented an €800bn (CAD$1.26 trillion) plan to increase European defence spending. Presumptive German Chancellor Friedrich Merz has said he will break Germany’s long-held deficit taboo to support increased defence spending. It’s a trend that has already seen some major market winners.
German arms manufacturer Rheinmetall AG has seen its stock skyrocket over the past few weeks. The stock is up over 100 per cent year to date, almost 200 per cent in the past 12 months. Other European defence names like Saab AB and BAE systems have also seen strong returns in recent weeks. The question arises that if Europe — representing around 15 per cent of global GDP — massively ramps up its defence spending, is now a moment for advisors to be talking with clients about defence stocks?
Francis Sabourin was asked that question and offered a wide-ranging analysis of the dynamics in the global defence sector today. The Senior Portfolio Manager and Senior Investment Advisor at Francis Sabourin Wealth Management of Richardson Wealth noted that he does not currently have his clients directly invested in any defence names. He outlined, though, that this theme can be played through first, second, and third order exposures which many different and somewhat unexpected companies can carry. He outlined why this run up in defence stocks has been largely localized to European markets, and how some advisors might want to tackle the ethical questions clients can have about this sector.
“For the past 50 years, Europe has relied on the United States for security, assuming unwavering support. However, the realization that this is no longer guaranteed will take time to fully set in, and the transition will not be seamless,” Sabourin says. “Achieving self-sufficiency in European defence would require an additional €250 billion in annual spending. European governments have signalled a commitment to increasing defence budgets, bolstering investor confidence in EU defence firms, which are expected to benefit from this surge in military expenditures.”
The US’ apparent withdrawal of support for Ukraine has accelerated this trend. With the news of a proposed ceasefire, there is a chance that the tempo of this trend changes somewhat. Nevertheless, the wider commitment to European security self-sufficiency appears to be in place.
Sabourin outlines that investors and advisors who want to play in this space have a number of available avenues. The most obvious is in first-order weapons manufacturing stocks. Companies like Rheinmetall that produce the weapons and material that will be in demand through these spending increases. He notes, though, that while European defence names have performed well, US defence names have stagnated or even fallen. Sabourin explains that the US Department of Defense has committed to significant budget reductions, which means cancelling or not renewing contracts with major US defence companies.
Second-order strategies could involve investments in more diversified industrial names with some defence business. Those include aerospace names like Boeing and Airbus, as well as logistics and infrastructure investments as countries in Europe look for ways to more rapidly move troops and material.
The third-order investment strategy, Sabourin explains, revolves largely around technology. Certain tech names like Palantir are directly exposed to global defence trends, and we’ve seen how the data analytics company has seen its stock value rise in part due to its use in conflict zones like Gaza. Other large tech names like Microsoft have involvement in the defence sector and can offer some clients exposure to this trend without the ethical concerns that can come with direct investment in a weapon’s manufacturer.
Defence stocks have long been an agreed upon no-go zone for ESG investors. Sabourin, however, notes how quickly that view has changed in Europe, where ESG investing is at its most widespread. In the context of preserving independence and democracy, these companies have been embraced by European investors, who had once sought to avoid the sector entirely. For Canadian advisors who want to recommend a defence exposure, Sabourin notes there could be value in looking at how the European view of these companies’ ethics has changed.
Advisors, too, should be cognizant of the risks facing investors in this sector. High valuations on some European weapons names could see volatility. Shifting political winds, like a potential end to the war in Ukraine, could generate swings in the other direction. The changing nature of technology, too, could see this sector upended.
“We can see AI being more sophisticated and being applied more often to this area,” Sabourin says. “With AI things are flying out the window because it evolves so fast. Countries will need to adapt to that. It’s like in WWI when the countries that adopted the tank were able to succeed. Applying this new technology to defence might see things change.”
