By Martin Baccardax

The U.S. has found itself at the center of an enormous shift in the global military industry, tied in part to the race to dominate artificial intelligence technologies, that could make a case for investing in defense and aerospace stocks over the long term.

That is the broad conclusion of an outlook published this week by BlackRock's Investment Institute, headed by Jean Boivin, looking into what it calls "mega forces" that drive longer-term investment trends.

In this case, Boivin and his team argue, U.S. pressure on NATO allies to boost their military spending heading into this week's summit in the Netherlands will prove to be a significant positive factor for stocks in aerospace and defense. He also notes the U.S. and China's differing positions on Russia's war with Ukraine, the continuing conflict in the Middle East, and the competition between Washington and Beijing over AI.

"Together, these dynamics are deepening geopolitical fragmentation and sparking investment in defense globally," Boivin said. "After undershooting for decades, military spending in Europe has now hit its target of 2% of GDP and is set to rise further," Boivin said.

"Many NATO members are expected to agree to up spending to 5% of GDP after this week's NATO Summit in The Hague with an expected 3.5% for defense and 1.5% for defense infrastructure," he added.

Stocks in aerospace and defense are already seeing huge moves as a result of those factors. A grouping of S&P 500 stocks in that sector has risen 33% since early April, well ahead of the benchmark's 21% advance, according to data from FactSet.

Yet even with the long spring rally, many valuations in the sector remain attractive. Shares of Lockheed Martin, General Dynamics, Northrop Grumman and Textron are all trading at lower multiples of the earnings expected over the next 12 months than the S&P 500.

There could be more gains ahead, however, as NATO members renew spending commitments and tap U.S. companies to develop their military hardware and technologies.

"We believe defense will emerge as a dynamic growth industry," said Stifel analyst Jonathan Siegmann. "The decades where the defense industrial base was optimized for no-growth are over. We believe equity markets will increasingly reward the companies that can profitably invest in the growing areas of defense."

The Stockholm International Peace Research Institute (Sipri), meanwhile, estimated world military spending hit $2.7 trillion last year, up 9.4% from 2023, in the biggest annual increase since the Cold War. Global AI spending, by contrast, won't top $630 billion until 2028, according to International Data Corporation forecasts.

"As governments increasingly prioritize military security, often at the expense of other budget areas, the economic and social trade-offs could have significant effects on societies for years to come," said Sipri researcher Xiao Liang.

The Republican spending bill, which is now being debated in the Senate, is likely to add around $113 billion to the Pentagon budget for next year. That would take total discretionary military spending past the $1 trillion mark.

That likely would allow for around $25 billion in spending on drone technologies alone, said Tony Bancroft, portfolio manager at Gabelli Funds. He believes that figure could reach $50 billion by 2035.

"The U.S. is still by far the largest drone builder in the world, it's always been the most dominant and I believe we will continue to be," he said. "We'll pair that dominance with our manned systems that are capable of controlling these drones."

Bancroft likes companies such as Textron, Honeywell, and L3Harris, all of which make components that comprise the military drone systems.

"These are obviously intricate, high-tech systems that require specific structures and electronics," he said. "We like those companies -- they're diversified across multiple programs, active on the commercial side as well, and they generate strong cash flow with long-term secular tailwinds."

BlackRock's team sees value in European defense stocks, but says the fact that many of those names have already made major moves this year means it makes sense to "stay selective for now."

In the U.S., where military spending levels are more than double those in Europe, BlackRock sees room for gains in defense technology.

"Growing geopolitical fragmentation and strategic competition in AI are reinforcing the global focus on national security and resilience -- creating opportunities in defense," BlackRock said. "But as both mega forces evolve, they call for a selective approach."

Write to Martin Baccardax at martin.baccardax@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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June 24, 2025 11:36 ET (15:36 GMT)

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