War Games, Real Markets: The Defense Build-Up Investors Pretend Not to See

Markets used to believe that war would never break out because it was tragic, unstable, and eventually contained. That presumption is being undermined. As if geopolitics were background noise, equity analysts continue to discuss rate cuts and consumer sentiment despite the fact that defense budgets are increasing in German factory towns and Brussels policy corridors with a seriousness not seen in decades. Investors might be tied to the protracted peace that followed the Cold War, when globalization reduced prices, spurred economic growth, and rendered war appear economically illogical.

Capital moved in the direction of efficiency for forty years. Across continents, supply chains extended. Defense factories either consolidated or shrank. The peace dividend influenced investor psychology and business strategy in addition to being political rhetoric. The concept of significant industrial mobilization seemed archaic outside of the former Soviet bases that were now used as logistics centers. Just-in-time inventory, software, and outsourcing were rewarded by the markets. Ammunition and tanks appeared to be artifacts. Unevenly, that era is coming to an end.

While NATO is expected to spend close to $9 trillion over the next six years, the Russian invasion of Ukraine shocked European governments into spending commitments of over $400 billion a year. However, the numbers are outpaced by the physical reality. Even though production lines in industrial towns in Germany and Poland operate in multiple shifts, executives continue to discuss two-year component lead times and steel shortages. Restarting idle production lines can take up to three years, according to one European manufacturer, serving as a reminder that parliamentary votes cannot create industrial capacity.

It appears that investors think this upswing is short-lived. There is a persistent belief that spending will decrease as the war subsides, budgets become more constrained, or public interest wanes. However, the battlefield has evolved. Multimillion-dollar armor is being destroyed by inexpensive drones. Entire formations are disrupted by electronic jamming. Now, factories are as frequently the target of cyberattacks as networks. The military is rebuilding domestic production capacity, rewriting doctrine, and retraining forces in addition to replacing equipment. A longer runway than what markets seem willing to price is implied by that.

A more subdued change is also taking place. Defense is no longer limited to shipbuilders and missile manufacturers. The modern defense perimeter now includes robotics engineers, cybersecurity companies, satellite operators, and AI analytics providers. An order for fighter jets might not be as important as a Microsoft cloud contract safeguarding military networks. Autonomous systems developed by small robotics companies are now strategic assets. It appears that the definition of “defense contractor” is growing more quickly than conventional sector classifications can keep up with this change.

Under stress, the industrial base itself appears brittle. In the United States, war-gaming exercises have simulated embargoes that cut off vital raw materials, cyberattacks that disable production lines, and missile strikes on logistics hubs. Shortages during the COVID era provided a sneak peek: efficient supply chains quickly break down under stress. These rifts deepen during times of war. Executives who take part in these simulations frequently come away feeling uneasy because they have to face the possibility that commercial dependencies could impede military readiness.

Europe is similarly vulnerable. Chemical inputs and specialty metals obtained from sources outside the EU continue to limit ammunition production. Some factories produce complex systems in small quantities rather than in large quantities, much like artisan workshops. According to a French parliamentary report, guided versions of 155-millimeter artillery shells could take up to three years to deliver. Tens of thousands of shells have been fired every week by Ukraine in the meantime. There is a glaring disparity between production and consumption.

Defense firms, however, are wary. Long-term contracts are necessary for capacity expansion, and defense ministries are infamous for changing their priorities. Executives are hesitant to construct new facilities that might remain idle during times of peace if demand visibility is unclear. Whether governments will continue spending after the current crises subside or internal pressures increase is still up in the air.

History provides hints. Defense companies were the market’s darlings in the 1980s. Decades of neglect and consolidation followed. The modern industry is more specialized, leaner, and perhaps less able to grow quickly. Ironically, that restriction might give businesses that can provide vital systems more pricing power.

Prime contractors with strong political ties are the clear winners, but a second tier is starting to emerge. European consumers are becoming more interested in South Korean products. New markets could be opened if Japanese export restrictions are loosened. Modernization efforts in India are speeding up. Russian suppliers may be displaced by European manufacturers in some regions of Asia and Africa. The defense supply chain is being subtly redrawn by the geopolitical landscape.

The contradiction between governments preparing for long-term strategic competition and markets still fixated on short-term earnings cycles is difficult to overlook. Supply chains, civilian-military cooperation, and industrial resilience are all being put to the test during war games. In the meantime, stability is implied by equity valuations.

Investors might be correct. Perhaps factories slow, budgets shrink, and tensions are reduced by diplomacy. However, it seems premature to assume a rapid return to peace-dividend economics while standing close to a logistics yard in Eastern Europe, where technicians labor under floodlights and armored vehicles wait for upgrades.

An increasing number of people believe that the rearmament cycle has industrial, geopolitical, and technological roots. The defense build-up might not be a spike if that is the case. It might be a reset of the baseline, taking place so gradually that markets, accustomed to decades of peace, find it difficult to notice at the time.