Defense Sector Soars: Why 2025 Could Be a Banner Year for Defense Stocks

The defense sector is capturing significant investor attention as we head into a busy earnings week, with major players like RTX, Lockheed Martin, and L3 Harris set to report. According to Citi analyst Jason Gurski, the sector is positioned for substantial growth driven by rising global defense budgets and emerging technological frontiers.

Strong Fundamentals Drive Sector Optimism

The defense sector ETF (ITA) has been performing well, hitting intraday highs earlier this week. This momentum reflects underlying fundamentals that have analysts increasingly bullish on the space.

"It's hard not to like both sides of the ledger," Gurski notes, referring to both defense and aerospace opportunities. "Rising budgets both here in the United States and in Europe provide a lot of visibility for these companies."

Key Catalysts for Growth

Increased Defense Spending: The sector benefits from a global trend of rising defense expenditures, with both U.S. and European allies ramping up their military investments.

Program Transitions: Many defense contractors are moving past poorly performing post-pandemic programs and signing new, more profitable contracts that should drive margin expansion.

Growing Pipeline: Companies are reporting increased bidding activity and improved outlook for future bookings.

Top Investment Picks

Gurski highlights several companies positioned to benefit from current defense priorities:

Missile Defense Leaders

• RTX and Northrop Grumman: Well-positioned to capitalize on air and missile defense priorities, including the Iron Dome program

Shipbuilding Powerhouses

• Huntington Ingalls and General Dynamics: Set to benefit from increased investment in shipbuilding capacity to address the gap with Chinese naval production capabilities

Additional Favorites

• L3 Harris
• General Dynamics (also benefits from land systems)

The European Opportunity

One of the most compelling growth drivers is the dramatic shift in European defense spending. European nations are transitioning from approximately 2-2.5% of GDP on defense to a target of 3.5% on pure defense spending, and up to 5% when including supporting infrastructure.

"The United States has been spending 3 to 5% of our GDP on defense for decades," Gurski explains. "The Europeans up until recently were sub-two. They don't have the IP, the capacity, the most capable sets of weapon systems."

This creates a significant opportunity for U.S. defense contractors, particularly in:
- Air and missile defense systems
- Fifth-generation fighters like the F-35
- Advanced weapon systems where European capabilities lag

Emerging Technologies and M&A Activity

The defense landscape is evolving rapidly, with new focus areas gaining prominence:

Defense Tech Revolution

• Unmanned and autonomous systems
• "Attributable mass" solutions inspired by Ukraine conflict lessons
• Integration of AI and advanced software platforms

M&A Landscape

Private companies like Anduril are actively acquiring smaller firms to expand their software platforms across multiple defense systems. However, Gurski notes that large-cap defense companies may be cautious about acquiring defense tech firms at current valuations, requiring "a lot of faith that the revenue is going to pull through."

What to Watch in Earnings

As major defense contractors report next week, investors should listen for:
- Commentary on growing bidding activity
- Outlook for future bookings and contract wins
- Margin expansion guidance as legacy programs conclude
- International sales growth, particularly in Europe
- Investment in new technologies and capabilities

Investment Implications

The defense sector appears well-positioned for sustained growth driven by:
1. Secular trends: Rising global defense spending creates long-term visibility
2. Margin expansion: Transition from legacy programs to new, profitable contracts
3. International growth: European defense spending surge creates new market opportunities
4. Technology evolution: Emerging defense tech creates new revenue streams

For investors considering exposure to the defense sector, the combination of traditional defense contractors benefiting from increased spending and emerging technology companies driving innovation presents multiple avenues for potential returns.

The sector's performance this week and the upcoming earnings reports will provide crucial insights into whether these bullish fundamentals are translating into financial results that justify current valuations and future growth expectations.