Defense stocks are on fire.
After stellar gains in 2025, these companies kicked off 2026 with even more momentum. L3Harris and Huntington Ingalls jumped 11% in just five trading days. Drone maker AeroVironment soared over 40%. Even the usual heavyweights like Lockheed Martin and Northrop Grumman climbed 4% or more.
But then came Wednesday.
President Trump dropped a bombshell: defence contractors must stop paying dividends and buying back shares until they speed up weapons production. Stocks tumbled. Investors panicked.
Thursday brought the twist.
Trump proposed a jaw-dropping $1.5 trillion defence budget for 2027, up from $901 billion this year. Defence stocks roared back, with Northrop Grumman jumping 8.3% and Lockheed Martin gaining 6.4%. European defence stocks hit all-time highs.
The question investors are asking: is this the sector to bet on?
Why the sudden love for defence?
The world, simply put, is getting more dangerous.
Russia’s invasion of Ukraine reshaped the geopolitical order. Now, Trump’s administration has removed Venezuela’s Maduro from power and is keeping US military involvement in the region for years. Tensions between the US and China aren’t cooling down either.
Trump has also pushed allies in Europe and Asia to spend more on their own security while planning ambitious programs at home like the Golden Dome missile-defense system.
All this instability means one thing: governments need more weapons, faster.
And defense contractors are the only game in town.
The carrot and the stick
Trump’s approach is a fascinating mix.
On one hand, he’s threatening to cap executive pay at $5 million and blocking dividends and buybacks until companies build new production plants. He singled out Raytheon for being “the least responsive” to military needs.
That’s the stick.
On the other hand, he’s dangling a $1.5 trillion budget, nearly doubling current spending. Analysts estimate this could boost Northrop Grumman’s earnings by 13% and General Dynamics by 11%. Smaller players like AeroVironment could benefit even more.
That’s a pretty massive carrot.
The dividend and buyback restrictions aren’t trivial. Lockheed Martin, for instance, raised its dividend for the 23rd consecutive year and authorized $2 billion in share buybacks recently. Major defense firms typically buy back about 1.8% of their market caps annually and pay dividends averaging 1.9%.
But Morgan Stanley analysts called the impact “manageable” compared to the upside from increased spending.
The risks lurking beneath
Not everything is rosy.
First, that $1.5 trillion figure needs congressional approval. While Republicans control both chambers and have shown little appetite to oppose Trump, analysts like William Blair’s Louie DiPalma suggest it’s likely “the starting point in a negotiation.” Congress might approve something closer to the $150 billion increase from last summer’s bill.
Second, valuations are stretched.
While some players trade at discounts to the broader market, leaders like RTX have climbed significantly. Kratos Defense and Palantir trade at over 100 times forward earnings. That’s expensive by any measure.
Third, peace might actually be bad for business.
Negotiations to end the Ukraine war are progressing, with breakthroughs on security guarantees for Kyiv. A ceasefire, according to BCA Research’s Matt Gertken, “will create a setback for defense stocks” even if it presents a buying opportunity later.
Our take
Defense stocks are riding powerful tailwinds: geopolitical instability, rising government spending, and the changing nature of warfare. The sector outperformed significantly in 2025, and early 2026 results suggest more gains ahead.
But timing matters. Short-term traders face volatility from Trump’s policy whiplash and stretched valuations. Some analysts believe major players look overbought and are due for a pullback.
For long-term investors, the thesis is compelling. The world isn’t getting safer anytime soon. Defense spending will likely remain elevated regardless of who occupies the White House or which conflicts resolve. Companies that successfully modernize production and deliver next-generation weapons systems should benefit for years.
The question isn’t whether defence stocks will do well, but whether you can stomach the bumpy ride. With Trump’s unpredictable executive orders, congressional negotiations ahead, and potential peace deals that could dampen enthusiasm, expect plenty of volatility.
For those with patience and strong stomachs, defense might just be the sector to watch.
Sonia Boolchandani is a seasoned financial writer She has written for prominent firms like Vested Finance, and Finology, where she has crafted content that simplifies complex financial concepts for diverse audiences.
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