European defense values lag behind the reassessment of conflict beneficiaries

Investor enthusiasm for European defense stocks has faded as profit-taking and stretched valuations collide with increasing uncertainty about the future of warfare, with the Iranian conflict underscoring the cost-effectiveness of low-cost drones.

The MSCI Europe Aerospace and Defense index fell by 9.2% in March, its steepest monthly decline in five years, marking the beginning of unwinding an exceptional trade.

Defense stocks typically rise at the onset of a conflict – such as after Russia’s invasion of Ukraine in 2022 – or when U.S. President Donald Trump pressures NATO allies to increase military spending.

Since the outbreak of the Iranian conflict on February 28, however, this has not been the case, despite Trump’s criticisms of NATO for lack of support for American military actions.

“We have observed significant ‘de-grossing’ movements as financial institutions and retail investors sought to reduce their exposure in a context of increased uncertainty,” said Martin Frandsen, portfolio manager at Principal Asset Management.

Shares of Czech weapons manufacturer CSG have lost over a third of their value since the conflict began, while German companies Rheinmetall and Renk have retreated around 10% and Swedish Saab by nearly 12%.

European defense stocks have been among the market’s best performers since the invasion of Ukraine in February 2022, showing an increase of more than 450%, compared to about 40% for the MSCI Europe index.

The rally has been fueled by European governments’ promises to increase military budgets and by Germany’s loosening of budgetary rules last year to accelerate rearmament.

However, order intakes have been slower than expected by some investors, with delayed or staggered contracts due to budget pressures in countries like France and the UK, according to Morgan Stanley analysts.

Rheinmetall, a producer of tanks, ammunition, and anti-aircraft defense systems, has said it is “inevitable” that countries will spend more on aerial defense as the war in Iran continues, but this has not been enough to stem the sector’s decline.

While investors remain generally optimistic, enthusiasm has waned, and heavily crowded long positions have been reduced, according to a recent note from Citigroup. Overcommitment can amplify price movements when sentiment reverses.

“The onset of the war in Iran, the sharp rise in energy prices resulting from it, and disruptions in supply chains seem to have swept away all sorts of crowded trades,” analyzed Louis-Vincent Gave, CEO of Gavekal Research.

“Thus, just like gold, silver, copper, and other metals experienced an aggressive decline, defense stocks followed suit.”

Valuations have also weighed. At the beginning of the conflict, the European aerospace and defense index was trading at about 29 times earnings forecasts, close to a record set at the end of 2025.

“An increase in defense budgets in the coming years was already integrated into global sector prices,” highlighted Aarin Chiekrie, equity analyst at Hargreaves Lansdown.

“Therefore, the recent pullback is partly explained by growth expectations that had been overheated.”

The Iranian conflict has highlighted both the cost and intensity of modern warfare, with Gulf states firing hundreds of American-made Patriot anti-missile interceptors, each priced around $4 million.

Simultaneously, the war has revived the demand for cheaper military solutions, which have also gained importance in Ukraine, such as attack drones and drone interceptors, much like the one produced by Ukrainian Terra Drone, a subsidiary of Japanese Terra Drone.

“The question of ‘the future of war’ has shifted since the start of the Iranian conflict, with the increasing role of new technologies like drones, which are much cheaper, challenging the demand for traditional, more expensive platforms,” explained Ciaran Callaghan, head of European equity research at Amundi.

Some European defense groups are heavily investing in drones, as well as in surveillance and anti-drone systems.

For example, Rheinmetall partnered with American Anduril last year to jointly develop European variants of Anduril’s Barracuda and Fury drones.

Despite the correction, analysts believe that the long-term investment thesis for European defense remains strong, with public spending commitments continuing to grow, and capital flows indicating selective buying on retreat.

Data from LSEG shows net inflows of $1.32 billion into the WisdomTree Europe Defence ETF since the beginning of 2026, with $377 million netted since the start of the war in Iran.

Two smaller defense ETFs, iShares Europe Defence and HANetf Future of Defense, together attracted $355 million this year, with $124 million since the conflict began.

“The long-term growth scenario remains intact… driven by the need for countries worldwide to rebuild their capabilities after decades of underinvestment,” concluded Aarin Chiekrie from Hargreaves Lansdown.