Geopolitics has returned with a vengeance. After 30 years of the "Peace Dividend," the world has entered a new era of Great Power Competition, driving defense spending to levels unseen since the Cold War. Global military expenditure crossed $2.8 trillion in 2025—a 15% jump in just two years—and 2026 budgets signal acceleration, not moderation. For investors, the aerospace and defense (A&D) sector has transformed from a sleepy, yield-focused corner of the market into a high-growth imperative.
The Paradigm Shift: From Asymmetric Warfare to Peer Conflict
For two decades, Western militaries optimized for counter-insurgency: lightly armored vehicles, precision drones, and special forces. That era is over. The wars in Ukraine and the Middle East, combined with rising tensions in the Indo-Pacific, have exposed critical gaps in conventional warfighting capability.
Nations are relearning harsh lessons: ammunition stockpiles are woefully inadequate, air defense is non-negotiable, and industrial bases cannot surge production overnight. The result is a synchronized global rearmament cycle focused on three priorities:
Munitions & Missiles: Replenishing depleted stocks of 155mm artillery, Javelins, Stingers, and Patriots.
Air Superiority: Next-generation fighters (NGAD/GCAP) and autonomous wingmen (CCA).
Space Dominance: Proliferated low-earth orbit (pLEO) constellations for resilient communications and surveillance.
The Budget Reality: 2% is the Floor, Not the Ceiling
NATO's 2% of GDP defense spending target—long ignored by major European powers—is now the baseline. Germany, France, and the UK have committed to sustained increases, with Poland targeting 4% and Baltic states exceeding 3%. In the Pacific, Japan has abandoned pacifist constraints, doubling its defense budget to become the world's third-largest spender by 2027.
In the U.S., the defense budget has breached $900 billion, with bipartisan consensus pushing toward $1 trillion by 2027. Unlike discretionary spending, defense outlays are structurally sticky; once programs enter procurement, they create multi-decade revenue streams.
The Prime Contractors: Fortresses of Cash Flow
The "Big Five"—Lockheed Martin, RTX (Raytheon), Northrop Grumman, General Dynamics, and Boeing (defense unit)—operate as regulated monopolies with insurmountable moats. High barriers to entry, classified technology, and entrenched supply chains make them immune to Silicon Valley disruption.
Lockheed Martin (LMT): The F-35 remains the cornerstone of Western air power, with orders backlog stretching into the 2030s. Its missile division is running 24/7 shifts to meet demand for HIMARS and PAC-3 interceptors. Trading at 16x forward earnings with a 2.8% yield, LMT offers growth at a value price.
RTX Corp (RTX): The world's premier missile maker. From Patriot air defense to AMRAAM air-to-air missiles, RTX products are in every conflict zone. Its commercial aerospace division (Pratt & Whitney) provides a diversified profit engine as global travel recovers.
General Dynamics (GD): The quiet giant of naval shipbuilding and land combat vehicles. With the U.S. Navy aiming for a 355-ship fleet and the Army modernizing its Abrams tanks, GD's backlog is at record highs. Its Gulfstream business adds a high-margin commercial kicker.
The New Growth Engine: Defense Tech & Space
While the primes dominate platforms, the explosive growth is in "Defense Tech"—agile companies integrating AI, autonomy, and software into the kill chain.
Palantir Technologies (PLTR): The operating system of modern warfare. Its Gotham platform integrates data from satellites, drones, and sensors to provide real-time battlefield awareness. With government revenue growing 20%+ annually, Palantir has become mission-critical for U.S. and allied command centers.
Anduril Industries (Private/IPO candidate): The SpaceX of defense. Founded by Palmer Luckey, Anduril builds autonomous drones, counter-UAS systems, and AI-powered surveillance towers. Its "Dive-LD" autonomous submarine and "Roadrunner" interceptor represent the future of low-cost, mass-producible attritable systems.
Space Sector: SpaceX's Starshield (military Starlink) has proven that distributed satellite constellations are harder to kill than exquisite, billion-dollar satellites. L3Harris and Northrop Grumman are winning billions to build the Space Development Agency's tracking layer.
The Industrial Base Challenge: Supply Chain as the Bottleneck
The biggest risk to the A&D bull case isn't demand—it's supply. The defense industrial base (DIB) atrophied after the Cold War. Consolidations reduced the number of prime contractors from 50 to 5. Shipyards closed. Skilled welders and machinists retired.
Ramping production of 155mm shells from 14,000 to 100,000 per month has taken three years. Solid rocket motor shortages constrain missile deliveries. This supply-demand imbalance gives pricing power to sub-tier suppliers:
TransDigm (TDG): The ultimate pricing power play. Makes proprietary aerospace components with 50% EBITDA margins.
Hexcel (HXL) & Woodward (WWD): Critical suppliers of composites and control systems.
Huntington Ingalls (HII): The sole builder of U.S. aircraft carriers.
Valuations: Not Cheap, But Rational
Defense stocks trade at a premium to the S&P 500 (18-22x forward earnings vs. historical 14-16x). Critics argue the "war premium" is priced in. Bulls argue the duration of growth is underestimated.
With 3-5 year backlogs providing unrivaled visibility, A&D stocks behave like "growth bonds"—offering defensive characteristics in recessions (government pays the bills) and inflation protection (cost-plus contracts pass expenses to the customer).
The Geopolitical Put
Investing in defense is, grimly, a hedge against global instability. When geopolitical crises erupt, the S&P 500 sells off while defense stocks rally. A 5-10% allocation to A&D acts as portfolio insurance that pays dividends.
Investment Strategy 2026
Core Holdings (60%): A basket of LMT, RTX, GD, and NOC for stability, dividends, and steady 8-12% compounding.
Growth Satellites (30%): Exposure to defense tech (PLTR, SHIELD ETF) and space infrastructure (L3Harris, Rocket Lab) for 20%+ upside.
Supply Chain Specialists (10%): Mid-cap suppliers (HII, BWXT for nuclear propulsion) with M&A potential.
Conclusion: The Long War for Capital
The world isn't getting safer. Deterrence is expensive, and rearmament is a multi-decade commitment. In 2026, the defense sector offers a rare combination: accelerating revenue growth, fortress balance sheets, and insulation from the economic cycle.
For investors, the moral complexity is real, but the investment thesis is undeniable. As long as nations feel insecure, the defense industry will thrive. The supercycle has only just begun.