Europe’s Defence Rally Is Running Out of Road

EBM NEWSDESK ANALYSIS-Nick Staunton- Editor-in-Chief

The stocks that defined European markets in 2025 are losing momentum in 2026. Order intake is slower than expected, fiscal constraints are biting and the crowded trade is being unwound. The defence supercycle is real — but the easy money has already been made.

European defence stocks were the defining trade of 2025. Rheinmetall rose close to 200% in twelve months. SAAB gained 28% in the opening days of 2026 alone. BAE Systems surged 6% on a single earnings beat in February. The Morningstar Developed Europe Aerospace and Defence Index posted its best ever start to a year. Investors who positioned early in the rearmament thesis made extraordinary returns.

That trade is now in reverse. The Stoxx Europe Aerospace and Defence index is down 1.2% year-to-date against a 4.8% return from the broader Stoxx 600. Rheinmetall — the sector’s bellwether — sits almost a quarter below its September peak. The question facing institutional investors is no longer whether Europe will spend more on defence. It will. The question is whether the stocks have already priced in everything that spending will deliver — and the answer, increasingly, is yes.

What Drove the Rally

The thesis was straightforward and largely correct. Decades of chronic underinvestment in European defence capability, combined with Russia’s invasion of Ukraine and the Trump administration’s explicit pressure on NATO allies to meet the 2% GDP spending threshold, created a structural demand signal that markets had not previously priced. Germany’s decision to loosen its constitutional debt brake and commit a €500 billion multi-year package covering defence, infrastructure and industrial capacity was the single most significant policy shift. It validated the rearmament narrative at scale.

The numbers followed. Among EU members that are also NATO allies, defence spending now averages firmly above 2% of GDP, with forecasts pointing toward continued increases through the decade. France has reaffirmed plans to move toward 3 to 3.5% of GDP under its updated military programming law. The structural case for European defence contractors — Rheinmetall, Leonardo, Thales, KNDS, BAE Systems — remains intact.

Why the Rally Has Stalled

The problem is not the demand. It is the delivery timeline between political commitment and commercial contract, and the fiscal constraints that are slowing that delivery in the markets that matter most.

Order intake has been slower than investors expected. Morgan Stanley analysts have specifically flagged contract delays and phasing in France and the United Kingdom, driven by fiscal pressure in both countries. France is running a deficit that limits near-term procurement flexibility despite the headline spending commitments. The UK defence budget increase announced in the March spending review was front-loaded with commitments that take years to translate into revenue for individual contractors.

The Iran war, which erupted in February and initially appeared likely to accelerate European defence procurement, has not delivered the expected contract surge. Rheinmetall acknowledged as much directly — it called increased air defence spending “inevitable” but that statement did not stop its share price retreating. Markets had already priced the inevitability. They are now waiting for the invoices.

Citigroup’s recent note captured the positioning dynamic precisely. Crowded bullish positions are being trimmed. When everyone owns the same trade and the catalyst for the next leg higher is delayed, the unwind is mechanical rather than fundamental. Morningstar equity analyst Loredana Muharremi put it plainly: investors are becoming very picky and very selective.

The Structural Case Remains Intact

None of this means the defence supercycle is over. It means the first phase — the re-rating phase, in which markets applied new and higher multiples to earnings that were already being generated — is complete. The second phase, in which actual order growth and earnings delivery have to justify those multiples, is just beginning. That phase is harder, slower and more stock-specific.

The defence sector now makes up almost 5% of the Morningstar Europe Index — a weighting that would have been inconceivable five years ago and that reflects genuine structural change in how capital allocates to European equities. Long-term inflows remain positive. LSEG data shows net inflows of $1.32 billion into the WisdomTree Europe Defence ETF in 2026, including $377 million since the Iran war began. Institutional capital is not leaving the sector. It is becoming more discriminating within it.

The longer-term growth picture remains intact, as Hargreaves Lansdown’s Susannah Streeter has noted. Countries rebuilding military capability after decades of underinvestment represent a demand cycle that extends well into the 2030s. The pipeline is real. The question is how much of it has already been priced into stocks trading at elevated multiples relative to near-term earnings delivery.

The Risks the Rally Obscured

The sector’s outperformance in 2025 compressed the risk premium that defence stocks had historically carried. Those risks have not disappeared. Large procurement contracts routinely face delays and cost overruns that erode contractor margins and strain government relationships. Export licences can be revoked or delayed. EU procurement rules favour domestic suppliers in ways that create winners and losers at the national level rather than across the sector as a whole. And the fiscal arithmetic in several major European economies — France and the UK most visibly — creates genuine uncertainty about the pace of spending commitment translating into signed contracts.

The defence supercycle is real. The era of indiscriminate buying within it is over. What comes next is stock-picking in a sector where the macro tailwind is strong but the micro execution risk is being repriced at exactly the moment valuations leave the least room for disappointment.

“Rheinmetall is almost a quarter below its September peak. The Stoxx Europe Aerospace and Defence index is underperforming the broader market. The defence supercycle is intact — but the easy money has already been made.”

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