NATO countries will raise defense spending to 5% of GDP. Which arms manufacturers will benefit?

NATO leaders agreed at the summit in The Hague to increase defense spending from the current 2% of GDP to 5%. Of this, 3.5% will be basic defense spending, and another 1.5% will be related investments, including infrastructure and cybersecurity. For defense companies, this means new multibillion-dollar contracts, analysts say. They named specific companies that investors should look out for.

NATO countries have agreed to increase their defense spending to 5% of GDP by 2035, according to a declaration adopted at a summit in The Hague. The current level is 2% of GDP.

«These investments will provide us with forces, capabilities, resources, infrastructure and enable us to build up our combat readiness and resilience,» the document said.

The decision to increase defense spending was a major victory for Donald Trump, notes Bloomberg. The U.S. president has repeatedly criticized his European allies for insufficient defense spending.

«We won a big victory here,» Trump said at a news conference in The Hague, expressing hope that the additional funds would be spent on military equipment made in the United States, wrote Reuters. Trump also said he would «see what can be done» about supplying Ukraine with missiles for Patriot systems, which are manufactured by defense contractor RTX.

U.S. pressure on NATO allies to increase military spending will be a major positive for aerospace and defense stocks, predicted investment institute BlackRock in a statement from Barron's. And it is the U.S. that is at the center of a shift in the defense industry, due in part to the dominance of artificial intelligence, which creates a favorable environment for investing in defense and aerospace securities over the long term, the institute said.

Shares of companies in the aerospace and defense sectors have been actively growing in recent months under the influence of these factors: securities of this segment in the S&P 500 index have risen by 33% since the beginning of April, which significantly outpaced the overall growth of the benchmark itself by 21%, Barron's cited FactSet data.

However, even after a prolonged spring rally, many stocks in the sector remain attractive: The securities of Lockheed Martin (makes F-35 and F-22 fighter jets and missile systems), General Dynamics (Abrams tanks, warships and subs), Northrop Grumman (B-2 stealth aircraft) and Textron (drones, helicopters, armored personnel carriers) trade at lower P/E ratios (the ratio of a stock's current price to its projected earnings over the next 12 months) than the average of other stocks in the index, writes Barron's.

The Pentagon's budget next year is likely to exceed $1 trillion. According to Gabelli Funds portfolio manager Tony Bancroft, about $25 billion of that amount could be allocated to drone technology alone, and that figure could rise to $50 billion by 2035. He pointed to companies such as Textron, Honeywell (a supplier of control systems, sensors and jet engines) and L3Harris (an integrator of secure communications and intelligence systems), which supply key components for military unmanned systems.

While the defense industry typically doesn't generate a significant share of revenue, there are a number of companies that stand to benefit from increased spending in Europe and possible growth in the U.S., noted analyst Jordan Klein of Mizuho, writes CNBC. Among them, he singles out semiconductor company Analog Devices for decent defense contracts (REBs, radios, missile guidance processors) and MACOM Technology with a fast-growing defense division that makes radio components.

The BlackRock team also stresses that European defense stocks have potential, but notes that many of them have already shown significant growth this year, so it makes sense to act selectively now. As for the U.S., where military spending is more than double that of Europe, BlackRock still sees upside potential in the defense technology segment.

The Stockholm International Peace Research Institute (Sipri) estimates that global military spending reached $2.7 trillion last year, up 9.4% from 2023. This is the largest annual increase since the Cold War.

«We believe the defense industry will become a dynamic growth industry,» said Stifel analyst Jonathan Sigman, who was quoted by Barron's. - Decades of a defense industrial base optimized for lack of growth are coming to an end. We are convinced that stock markets will increasingly reward companies that can profitably invest in promising areas of defense.»

«As governments increasingly prioritize military security, often at the expense of other budget items, economic and social trade-offs can have a significant impact on societies in the long term,» warned Sipri researcher Xiao Liang.

This article was AI-translated and verified by a human editor