Why Defense Spending Plays Extend Beyond Defense ETFs

Oh, the spoils of war.

The House of Representatives narrowly passed a record $1.15 trillion annual defense budget last week. It still needs Senate approval, but Washington’s appetite for military spending is clear, and the US isn’t alone. The EU, Japan and Middle Eastern nations have all been ramping up defense budgets, too, creating real sector opportunities for portfolios. Capturing them, however, takes more than pure defense-category investing: It requires knowing where the money actually flows.

“The defense ecosystem is actually much larger than most investors think,” said Chris Grisanti, chief market strategist at MAI Capital Management. “It can include industrial companies like autos — GM has a big defense business — and of course technology and communications companies.”

War All of the Time

Beyond active conflicts in Ukraine, Iran and Gaza, much of today’s defense spending is being driven by the global AI arms race, as nations rush to defend against cyberattacks and threats to financial systems. “The increase in defense spending is huge, and it will flow into many sectors,” Grisanti said. “My favorite way to play it would be broad industrial companies.”

Looking at some of the biggest sector ETFs that could benefit from increased defense spending, we’re already seeing strong performance and flows:

• The State Street Industrial Select Sector SPDR ETF (XLI) is up almost 16% this year, with $3.6 billion in net inflows, per ETF Database. 
• The First Trust NASDAQ Cybersecurity ETF (CIBR) has surged 25% and taken in $470 million.
• The iShares US Telecommunications ETF (IYZ) has jumped 18% with roughly $470 million in flows of its own.

Pure-play defense ETFs, by comparison, are more mixed: 

• iShares US Aerospace & Defense (ITA) and Invesco Aerospace & Defense (PPA) are both up about 8%, though ITA has shed $175 million in outflows.
• Global X Defense Tech (SHLD) is down 5% yet still pulled in $2.6 billion in new inflows.

A Game of Risk: Bigger budgets don’t immediately mean bigger revenue for contractors, either. “The spending still has to get through Congress and become actual contracts,” said Louis Kondratev, a trading associate at XFUNDS. “That backlog will be realized as revenue over multiple years, not immediately, but the stock can move sooner since investors would price in future growth.”

Defense investing also carries a narrow customer base. “You always have government risk: Money gets delayed, contractors get sued, there are claims of defects,” Grisanti said. “All that happens with a regular customer, too, but when you have only one client, and it’s the government, it’s a risk.”