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13:51 16.08.2026 •
A storming rally in European defence stocks has gone into reverse this year on concerns over how the continent will fund its military spending plans and as investors instead look to drone makers and companies more focused on modern, high-tech warfare, Financial Times writes.
The Stoxx Europe Targeted Defence index has fallen more than 15 per cent since its peak in January, with much of that coming since the start of the US-Israeli war against Iran, wiping billions of euros from the values of companies including BAE Systems, Rolls-Royce, Thales, Leonardo and Rheinmetall.
The fall marks an abrupt reversal in what had become one of the biggest trades in European equity markets in recent years. The defence index had risen more than 40 per cent every year since 2022, when Russia invaded Ukraine, and in 2025 it almost doubled, fuelled by Germany’s massive infrastructure and military investment plans and a Nato agreement to raise defence spending to 5 per cent of GDP.
“Last year was all about ‘how great is this [spending]’,” said Charles Armitage, European defence analyst at Citi. “This year is all about ‘how are we going to pay for it?’”
Military spending plans have come under renewed scrutiny after government borrowing costs around the world soared this year because of the Iran war and the near-closure of the Strait of Hormuz, as the prospect of higher inflation raises expectations of interest rate rises.
At the same time, governments face growing pressure to offer relief to businesses and consumers hit by higher energy prices, putting a strain on state budgets in energy-importing Europe.
Emmanuel Cau, head of European equities strategy at Barclays, said: “Given all the concern with growing fiscal deficits and rising interest rates, and all this [defence spending] being funded by governments and debt issuance, the market is questioning the sustainability of this defence spending boom.”
Germany told France it will withdraw from plans to develop a joint fighter jet - the central element of the €100bn Future Combat Air System programme, which was set to be one of the continent’s biggest defence projects.
Meanwhile, Czech Prime Minister Andrej Babiš told the FT last week the country would “probably” miss the Nato spending benchmark of 2 per cent of GDP.
As concerns grow that commitments will not translate into spending, institutional investors have unwound their bigger-than-benchmark positions in the sector, according to State Street data.
These “supposed beneficiaries of war and rearmament have quietly become one of the worst performers this year”, said Marija Veitmane, head of equities at State Street. “Patience has run thin” on the theme, and “the market now wants proof, not promises.”
Laura Cooper, macro strategist at Nuveen, said that “investors are reassessing how quickly defence spending commitments can translate into revenue and earnings.
“Recent earnings have reinforced that... converting those orders into profits is a slower process than many investors had anticipated,” she added.
In Europe, Rheinmetall, Airbus and Thales all disappointed with their reported revenues in the first quarter of 2026, raising questions about whether investors had priced in too much optimism for those companies from greater defence spending.
Giles Parkinson, head of equities at investment firm TrinityBridge, said earnings growth in the defence names looks especially lacklustre next to the ballooning profits coming from the market’s AI darlings.
“Investors are looking for more tech-oriented defence stocks,” said Barclays’ Cau. “European defence is seen as old school, old economy… the defence stocks you want to buy now have more of a tech tilt.”
“Where is the money going to be spent? We have seen a huge change in the way in which wars seem to be fought,” said Citi’s Armitage, adding that the market appears to be in “the last stretch” of the European defence trade.
“The easy money has been made,” he said.
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