BAE Systems PLC (LSE:BA.) climbed to second place on the FTSE 100 leaderboard this week, as defence stocks rallied on the back of a deteriorating geopolitical backdrop that analysts say is reshaping investor expectations for military spending across Europe and beyond.
Shares in the UK’s largest defence contractor were buoyed by renewed tensions in the Middle East, including a mooted US intervention in Iran following an uprising, alongside unrest in Venezuela and increasingly confrontational rhetoric from President Donald Trump over Greenland.
Analysts argue that these developments have reinforced the case for structurally higher defence budgets, particularly in Europe, even as attention drifts away from the war in Ukraine.
In a note, JPMorgan said the European defence sector had risen by an average of 18% year to date, compared with a 3% gain for the wider Stoxx Europe 600.
The bank raised its price target for BAE Systems by 9% to 2,400p, citing the company’s exposure to naval and submarine programmes that could benefit from heightened strategic focus on the Arctic and northern Europe.
The analysts said that while Russia’s invasion of Ukraine remains the most important long-term driver of European defence spending, other flashpoints are now crowding the agenda.
“With the US administration now highly focused on ‘Western hemisphere’ issues, and the potential for more unrest in the Middle East, we wonder whether the US really has the bandwidth to continue its shuttle diplomacy between Russia and Ukraine,” the note said. As a result, Ukraine is increasingly becoming “Europe’s problem”.
Trump’s comments this week added to the volatility. After warning US defence contractors that dividends and share buybacks could be capped unless they invested more heavily in capacity and delivery, the president later suggested that the US defence budget could rise from about $1 trillion to $1.5 trillion in the next fiscal year.
JPMorgan cautioned that the figure may be an opening negotiating position, but said even a smaller increase would be well above market expectations and could eventually feed through to contractors’ order books.
Beyond the US, analysts highlighted Venezuela as a source of uncertainty with potentially far-reaching consequences.
JPM noted concerns expressed by European and Latin American leaders over whether Washington had breached international law, adding that the episode underscored a shift from a rules-based order to a more fragmented, multipolar world. “We believe that this is a world in which defence spending will only go higher,” the bank said.
Greenland has emerged as another pressure point. Although JPM said it was unlikely the US would attempt to take the territory by force, it argued that Washington’s rhetoric was straining relations with Europe and could have practical implications for defence procurement.
As Arctic routes open up and competition for resources intensifies, countries close to the region are expected to invest more heavily in submarines and warships.
That dynamic, the bank said, “significantly favours” BAE Systems, which is already in advanced talks to sell its Type 26 frigate to Norway.
JPMorgan said the price target increase for BAE reflected a willingness to apply higher valuation multiples in light of these trends, even though it may take several years for higher US or European budgets to translate into revenues.
In late afternoon trading, BAE shares were up 2.8% at 2,111p.