Ukraine Peace Talks Undermine European Defense Stocks

The defense sector was a casualty of potential peace on Monday. 

European arms-makers have been breadwinners all year for stock pickers, with the war in Ukraine motivating governments on the continent to upgrade their defensive capacity. Deal or no deal, that trend isn’t over, which is why some analysts found the selloff a head-scratcher. 

En Garde

Europe’s STOXX 600 index has climbed 11.5% this year and, like the S&P 500 on the other side of the Atlantic, has achieved a run of successive record highs. Underpinning the European rally is the aerospace and defense sector, up 45.9% this year as of Monday’s close. Russia’s invasion of Ukraine in 2022, which initiated the first large-scale land war on the continent since World War II, shocked governments into action and was followed by pledges of hundreds of billions in spending on regional security improvements.

Yet the prospect of peace spooked investors. The Stoxx Europe Aerospace and Defense index fell 2% on Monday, reaching the lowest point since early July. German defense firms Rheinmetall, Hensoldt and Renk were down 5%, 4.5% and 4.4%, respectively, while Sweden’s Saab tumbled 5.6%, Italy’s Leonardo 2.3%, and France’s Thales 1.5%.

Several analysts, however, say the selloff made no sense: 

• “Even if there is a deal agreed, the sector should not see a market-shock drop, as European defense valuations are underpinned by structural increases in defense budgets across Europe, rather than by short-term revenues from Ukraine,” Morningstar analyst Loredana Muharremi wrote in an investor note.
• “We see the sector as undervalued following the recent market correction, with over 20% potential upside,” added Muharremi.

The Bureaucrats’ Pledge: The European Commission estimates EU defense spending will reach €392 billion ($451 billion) this year, nearly double its level four years ago before Russia invaded Ukraine. The commission also forecasts €3.4 trillion ($3.9 trillion) will be spent on defense in the next decade. That’s going to last a lot longer than the current investor jitters.