The recent surge in European defence stocks has raised concerns that investors may be getting caught up in a market bubble, the Telegraph reports.
Shares in major defence contractors like BAE, Rheinmetall, Leonardo, and Thales have seen dramatic increases in value. Over just a few hours last week, BAE’s stock soared by 15%, while Rheinmetall’s shares have risen 60% over the past month. This surge is largely driven by heightened geopolitical tensions, particularly following the breakdown of diplomatic relations between the US and Ukraine. As a result, European leaders are considering significant increases to their defence budgets.
The sudden enthusiasm for defence stocks, however, raises red flags. Similar to the frenzied rallies seen with AI and cryptocurrency stocks in recent years, the sharp rise in European defence stock prices appears to be an unsustainable trend. While the prospects of increasing defence budgets are tempting, three key challenges suggest that the current boom may not last.
First, many European nations, including the UK and France, face significant financial constraints. In the UK, for example, defence spending hikes are being funded by cuts to other budgets, such as overseas aid. Similarly, France, which already has one of the highest tax rates in Europe, may struggle to secure additional funds without significant fiscal reforms. Meanwhile, Germany has announced plans to lift debt restrictions for defence spending, but these changes are still subject to parliamentary approval and would require time to implement.
Secondly, while some governments are easing investment restrictions to allow more funds to flow into the defence sector, this will likely only result in short-term boosts to stock prices. For instance, pension and investment funds that previously avoided defence stocks due to ESG concerns are now able to include these companies in their portfolios. However, this is not a sustainable growth strategy, and the impact on share prices may dissipate over time.
Lastly, the possibility of a peace agreement between Russia and Ukraine, while currently remote, cannot be ruled out entirely. Should such a deal come to fruition, European leaders may shift their focus to other pressing domestic needs such as welfare, healthcare, and education, rather than continuing to invest in military expansion. If the geopolitical landscape changes, the urgent demand for new defence equipment could quickly diminish.
