European Defense Stocks Surge in 2025: Strong Year-End Gains Amid Valuation Risks

The European equity landscape at year-end 2025 reflects a bifurcated performance: while major indices rallied over the year, the close of trading on December 31 showed modest losses or flatness in several markets. The STOXX 600, for example, declined ~0.1% in the last session but still logged a healthy ~16% gain for the year—its best since 2021. The FTSE 100’s ~21.5% return cresting since 2009 suggests strong UK sectoral performance, especially in mining, defense, and banking, which mitigated macroeconomic headwinds.

Defense stocks in Europe experienced an exceptional year. On the final trading day, firms such as Saab, Renk, and Rheinmetall gained ~2-3%, placing them among the top annual performers in the STOXX universe—Saab’s and Rheinmetall’s full-year returns approximate 130-193%. Broader sector indices saw annual returns of 50-60% for defense, supported by trends toward increased national military spending, infrastructure investment (notably in Germany), and looser regulatory environments around spending limits.

Macro-fundamentals underpinning this defense surge include: i) expectations that European governments will ease budget constraints to allow higher defense and security allocations; ii) geopolitical pressure from the war in Ukraine and diminishing clarity around U.S. commitments to NATO; iii) rising real yields and bond yields, impacting cost of capital but also rewarding real assets like defense equipment and infrastructure.

Risks and open questions remain. First, whether defense companies can sustain order fulfillment and supply chains amid inflation and logistical constraints. Second, valuation risk—after large gains, multiples may be stretched. Third, the impact of rising interest rates or fiscal tightening (despite recent stimulus) could curb financing availability. Fourth, regulatory and political overshoot: defense spending may draw pushback from electorates sensitive to deficits or competing priorities.

For investors, the outlook into 2026 suggests that the defense sector may retain tailwinds, particularly as spending commitments made in 2025 begin converting into procurement contracts and revenue. However, sector exposure should be balanced with scrutiny over margins, delivery capability, debt burdens, and the inflation sensitivity of input costs.