CONTRIBUTORS
Dina Ting, CFA
Head of Global Index Portfolio Management,
Franklin Templeton ETFs
While the United States is still by far the world’s largest spender on aerospace and defense, countries including the United Kingdom, Germany and Canada are increasing their military budgets at a faster rate. In fact, global defense spending last year reached a record high of nearly US$2.5 trillion—more than a 7% rise in real terms from the prior year and an average of 1.9% of gross domestic product.1 We see this as an ongoing trend, driven by rising threat perceptions and the demand for more modernized technologies, such as advanced cybersecurity and drone innovations that are increasingly reliant on artificial intelligence capabilities.
The European Union (EU) is now aiming for roughly US$870 billion in investments to strengthen its defense capabilities amid growing concerns over US commitments to European allies. While the implications for defense companies—such as specific allocation and concrete order timelines—are still being assessed, European defense stocks have already seen a dramatic upward trajectory in recent months. Once further details on orders can be clarified, we may see further upward adjustments to projections. What’s more, the significant boost in military spending is reshaping alliances worldwide and spurring investment opportunities in select markets.
Germany, Europe’s largest economy, is at the forefront of ramping up military spending, and equity markets have reacted favorably. German equities have surged year-to-date, with the DAX Index up more than 19% compared to a decline of over 2.5% for the S&P 500 Index.2 Europe’s developed market stocks have also trounced US stocks year to date, up more than 12%.3
Global Defense Spending Reaches New Heights
2020–2024
Sources: International Institute of Strategic Studies, The Military Balance+, US represents Office of Management and Budget-adjusted figures. Germany includes special fund allocation, military pensions and military aid to Ukraine. UK includes Armed Forces Pension Scheme and military aid to Ukraine. USD figures reflect IISS currency adjustments of national budget figures.
Investors pursuing the potential benefits of portfolio diversification may want to consider the cost-effectiveness of country-focused exchange-traded funds (ETFs). Among European equities, Germany has attracted the most positive net flows in ETFs year-to-date with US$5.9 billion, followed by Switzerland with US$2.2 billion, and ranks third globally by country in terms of ETF net flows.4
Of course, the latest US auto tariffs are expected to add further pressure to Europe, with particular pain for Germany's already struggling car industry. The country's three largest auto exporters account for about 73% of the EU's vehicle exports to the United States, according to JATO Dynamics.
Despite the strong performance of European stocks this year, relative valuations remain attractive to us. The STOXX Europe 600 is trading at 14.7x 2025 earnings, compared to 22.6x for the S&P 500.5
The significant rise in European defense spending is also notably impacting alliances elsewhere around the world. Since US President Donald Trump’s on-again, off-again tariff turmoil began, Canada has been further aligning itself with partners across the Atlantic, aiming to diversify its trading relationships and defense alliances beyond its primary ties with the United States.
We believe the trend of localization in the defense industry is creating significant opportunities in Asia, where defense budgets are also growing. While defense spending in Asia is growing at a more moderate pace than Europe and North America, Asian nations are pouring resources into developing next-generation military capabilities, which now account for 23% of global defense spending.6 Indian authorities, for example, recently announced a 9.53%7 rise in its defense budget for 2025-26 and are engaging more private companies to build military aircraft, which seems likely to create new opportunities in its aerospace sector.
As global defense spending climbs, nations are focusing on localizing defense production to boost self-reliance and reduce foreign dependency. Besides India, South Korea and Taiwan are also heavily investing in their domestic defense capabilities. In October 2024, Washington and Seoul finalized a new multiyear plan over the shared costs of keeping US troops on the peninsula. For 2026, the nations agreed to raise defense costs by 8.3% to roughly US$1.13 billion.8 Taiwan, meanwhile, is aiming to overhaul its military and lift defense spending to more than 3%9 of gross domestic product, up from its current 2.45% (though well short of the 10% of economic output that Trump has demanded.)
Given expectations for a sustained lift in global defense spending, investors may increasingly seek portfolio diversification with strategic country exposures. While defense spending is subject to future election outcomes and changes in geopolitical risks, we believe this approach may not only help potentially mitigate risks but also help investors to capitalize on the opportunities arising in new cross-border alignments.
Endnotes
- Source: International Institute for Strategic Studies (IISS). February 12, 2025.
- Source: Bloomberg. March 27, 2025. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.
- Source: Bloomberg. March 28, 2025. STOXX Europe 600 Price Index and FTSE Developed Europe RIC Capped Net Tax Index (in USD). Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.
- Ibid.
- Source: Bloomberg. As of March 31, 2025.
- Source: JP Morgan, Asia Pacific Equity Research. As of March 15, 2025.
- Source: Government of India, Ministry of Defence press release. February 5, 2025.
- Source: “U.S., South Korea agree on five-year plan to share defence costs.” Reuters. October 4, 2024.
- Source: American Institute of Taiwan, March 20, 2025.
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