Defense sector survives on stock markets thanks to Ukraine invasion

It has been a year in the red in the evolution of the main global stock markets. A reality marked by the inflationary component that has led to a hastily restrictive monetary policy to try to contain it. Ultimately, we started from an environment of high overvaluation in equities led by the growth segment and bonds with negative nominal yields.

In addition, since February 24, the Russia-Ukraine military conflict has been one of the catalysts in the short term, adding volatility to the market and putting pressure on oil prices.

In the midst of so much uncertainty, there are sectors that have managed to save the year and even provide positive returns. Today we will talk about the defense sector, a sector that is reaping the benefits of this situation.

First of all, let’s look at the sector’s stock market data from a historical perspective. From 1995 to the present day, the MSCI World Aerospace and Defense Index, which includes large and mid-cap global defense and aerospace companies in 23 developed market countries, has reported an annualized return of 10.86%, while the global stock market represented by the MSCI World Index has offered a return of 7.54%.

This is not an index with a large number of constituents, only 22 companies. Of these, three companies have a weighting of more than 10% in the index: Raytheon Technologies (18.43%), Lockheed Martin (13.91%) and Boeing Co (10.78%).

This year in particular, while the global equity market was down 13% through April, the sector contributed a positive return of 2%, a spread of 15 percentage points in just four months. The warlike tension that is driving higher defense budgets is being discounted in the market with rising prices. For example, Germany announced a historic change in defense policy and said it would launch a 100 billion euro fund to modernize its armed forces.

MSCI index
MSCI index

The defense sector has been boosted in the recent past following the 2014 Wales Summit. There, North Atlantic Treaty Organization (NATO) allies adopted the Defense Investment Commitment, thereby agreeing to spend at least 2% of GDP on the military and to allocate at least 20% of their military spending to arms procurement and military research and development (R&D).

Non-binding guidelines on military spending among NATO members date back to the early 2000s. However, it was not until 2014-largely spurred by the Russian annexation of Crimea-that NATO decided to formalize these objectives.

Going by the SIPRI report, in 2021 global military spending surpassed the $2 trillion mark for the first time, reaching $2.113 trillion.

Global spending in 2021 was 0.7% more than in 2020 and 12% more than in 2012. The economic effects of the Covid-19 pandemic have not put an end to the continuing upward trend in global military spending observed since 2015.

As a result of the strong economic recovery worldwide in 2021, global military spending as a share of global gross domestic product (GDP) – the global military burden – stood at 2.2%, down from 2.3% in 2020. Military spending measured as a percentage of government spending in 2021 remained the same as in 2020, at 5.9%.

There is a strong imbalance in global military spending. The top five countries in military spending in 2021 were the United States, China, India, the United Kingdom and Russia, which together accounted for 62% of global military spending. And, specifically, the United States and China alone accounted for 52%.

And, in response to the Russian invasion of Ukraine in February 2022, several European NATO member states had announced, by the end of March 2022, plans to increase military spending to meet or exceed NATO’s spending target of 2% of GDP or more. These member states included Belgium, Denmark, Germany, Lithuania, the Netherlands, Norway, Poland and Romania. The acquisition of new weapons systems will likely be at the center of these spending plans.

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