Global Equity Pulse: Conflict and opportunity

A shift back to Europe?

Much of the increase in defense budgets is driven by equipment-related spending, which is the component directly feeding into the revenue of aerospace and defense companies, as compared to personnel or infrastructure-related spending. So far, major US suppliers have been the key beneficiaries of this demand growth, but we think the recent cracks in the trans-Atlantic security partnership may lead to a partial or even significant pivot back to European suppliers.

From our bottom-up perspective, we look for companies with strong government backlogs, conservative balance sheets, consistent free cash flow and attractive valuation multiples. We believe these firms are best positioned to benefit as rising defense budgets flow through to order growth and long‑term earnings potential. Multi-year government contracts are important as they provide stable, predictable revenue regardless of economic cycles. 

We also look at the health of margins and sustainability of earnings power, among other factors. Some key considerations are: 

• Technological edge and the ability to adapt to new trends. The nature of warfare is changing, and military customers and adversaries are increasingly using offensive and defensive cyber and electronic warfare capabilities. One of our European favorites, a large UK-based aerospace and defense company, is already diverse, but it plans to continue to shape its portfolio toward these higher growth, technology-focused, and strategically important domains such as space, drones, counter-drones and electronic warfare.
• Exposure to increased defense spend: This company in our research universe is a strategic partner to the French military, deriving >40% of defense sales from the French state, which is also a 26% shareholder in the company. Its electronics and sensors are on all France's major defense platforms—fighter jets, frigates and air defense systems—and it has a ~25% share of France's national defense budget.

Investors should also keep in mind that some European defense majors have diverse sales exposure to not just Europe, but also the United States and Asia-Pacific countries. Ultimately, defense as an investment theme is not exclusive to Europe. At a time when a multi-polar world order is slowly but surely taking shape, nations spending more to build their own defense will likely be a permanent feature of the global security landscape, and a potentially lasting opportunity that investors can harness for long-term returns.  

Market review

Global equities rebounded strongly in April, with the MSCI All Country World Index (ACWI) rising 10.03% in US dollar terms, as markets recovered a substantial share of the March selloff. Performance was driven primarily by the partial unwinding of the energy shock that had dominated sentiment at the end of the first quarter. The announcement of a temporary US-Iran ceasefire, intermittent progress in talks, and periods in which the Strait of Hormuz appeared effectively open helped trigger sharp declines in oil prices and a broad relief rally across risk assets.

Outlook

In the United States, health care remains of particular interest given historically low valuations, stabilizing/improving fundamentals, and resolution of various macro-overhangs. European equities face a near-term energy headwind as Middle East tensions lift crude oil, liquefied natural gas (LNG) and refined product prices, weighing on growth and inflation. Yet medium-term prospects are improving, supported by competitiveness reforms, German fiscal stimulus and defense spending. In Asia Pacific, the bellwether semiconductor names in Taiwan and South Korea have reported record-high first-quarter earnings. Driven by the technology sector, regional earnings growth at the index level continues to look robust. We maintain our high conviction but will be selective in our allocations, focusing on the more resilient parts of the artificial intelligence (AI) value chain.