Are defence stocks the new big tech?

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Defence stocks seem to be displacing US big tech as investors’ number one hope for growth, according to new research.

Rolls-Royce (LON:RR.) topped the list of top stocks on Interactive Investor’s platform during June, and BAE Systems (LON:BA.) came in at number five. We could see even more defence stocks join these companies going forward as investors look to defence to deliver the kind of growth they’re used to seeing from big tech.

Microsoft entered the exclusive $4 trillion market cap club alongside Nvidia on 31 July. The Magnificent Seven stocks have been front and centre in investors’ minds for nearly three years.

But amid a rotation away from US stocks, and in light of unprecedented spending commitments from European nations, could defence stocks be the next source of growth for investors?

Trading platform IG surveys its clients twice a year to gauge UK retail investors’ sentiment towards the stock market.

The latest results show that UK investors think the defence and military sector will see the most growth over the next six months, knocking artificial intelligence (AI) off top spot.

“While AI sentiment remains bullish, the drivers behind the defence sector are stronger than ever, and investors are clearly responding to that momentum,” said Chris Beauchamp, chief market analyst at IG.

Of the 1,800 clients IG surveyed, 55% put defence stocks in their top three sectors for expected growth over the next six months – more than any other sector.

^{Source: IG}

Are defence stocks growing?

Industry giants like Rolls Royce and BAE Systems have captured much of investors’ attention this year, and the fundamentals are justifying the positivity.

BAE Systems announced its half-year results on 30 July and they underscored the growth its business is enjoying: revenue increased 11% year-on-year to £14.6 billion and underlying EBIT rose 13% to £1.55 billion.

“Although there were some concerns earlier in the year that the investor enthusiasm around BAE Systems was starting to falter, given its exposure to long term contracts, today’s update proves there is still reason to be optimistic towards the stock,” said Victoria Scholar, head of investment at Interactive Investor, at the time.

In its half-year results announced 31 July, Rolls Royce posted 11% year-on-year revenue growth (to £9.1 billion) and a 50% increase in underlying operating profit, to £1.7 billion, whilst boosting full year guidance from £2.7-2.9 billion to £3.1-3.2 billion.

Rolls Royce shares gained 8.5% the following session. As of close on 4 August, Rolls Royce shares have gained 91.7% so far this year.

The outlook for European defence stocks

Much of the boom in defence stocks has benefitted European companies in particular, stemming back from US president Donald Trump’s apparent laissez-faire approach to the NATO alliance.

“European defence companies have performed well under Trump’s presidency and amid the backdrop of global instability with the wars in Ukraine and the Middle East,” said Scholar.

As such there are concerns that the recently-announced EU-US trade deal could mark a resumption of closer ties between the US and Europe, especially with Trump simultaneously adopting a tougher stance towards Russia.

But Loredana Muharremi, equity analyst at Morningstar, believes the recent EU-US trade deal could benefit European defence stocks – even if it offers greater advantages to US firms in the sector.

“We don’t see the EU tariff deal as a negative for European defence,” she said. “In fact, it aligns with our view that the US defence sector will continue to play an important role within Europe’s defence ecosystem.”

European nations would have had to keep buying from the US given capability gaps and the urgent need for off-the-shelf equipment, but Muharremi expects that the trade deal means that “over time the share of equipment from the US will decrease, in favour of European primes”.

How to invest in defence stocks

Investors can buy defence stocks via a stocks and shares ISA.

Investors who want to increase their exposure to defence stocks without focusing on just one or two stocks could consider buying a defence fund or investment trust.

One example is the Future of Defence UCITS ETF (LON:NATO). This exchange-traded fund (ETF) gives exposure to a portfolio of forward-looking companies that have exposure to the defence theme, and are screened for NATO alignment: all holdings are domiciled in NATO or NATO-allied countries.