The $1.5 Trillion Arsenal: How America’s Record Defense Budget Is Re-Rating Defense Stocks in 2026

The United States is entering what analysts are calling the “Trillion-Dollar Defense Era.” The proposed FY2027 Pentagon budget of nearly $1.5 trillion reflects a fundamental shift in Washington’s strategic calculus. With simultaneous flashpoints in the Taiwan Strait, Eastern Europe, and the Middle East demanding hardware now, defense contractors are sitting on backlogs that will take years to fill.

That is the American half of the story, and it is the half everyone tells. The half that decides whether the current multiples survive is European, and it is measurable. NATO’s European members have committed to spending 5% of GDP on defence by 2035. As of the most recent complete year of data, they were spending 2.01%. The distance between those two numbers is the entire investment case — and the rate at which it closes is not a matter of opinion.

Lockheed Martin (LMT) reached an all-time high of $692.00, up +40.62% YTD, after securing a landmark $9 billion Saudi Arabia contract. General Dynamics (GD) has returned +72% over the past 12 months following a $15.4 billion Navy submarine contract. RTX carries a backlog of $268 billion and is up +30% YTD. (Price and return figures are as of publication, 25 March 2026, and will have moved since.) According to National Defense Magazine, global defense spending is set to top $2.6 trillion in 2026.

Key Takeaways

• $1.5 trillion: The proposed U.S. FY2027 defense budget — the largest in American history.
• 2.01%: What European NATO actually spent, combined, in the latest full year of data. The target is 5% by 2035.
• The pledge that took a decade: Europe agreed to 2% in 2014 and reached it, in aggregate, in 2024.
• What to watch: Not announcements. Outlays, and the order backlog they convert into.

European NATO defence spending

2.261.47

Source: SIPRI and national accounts via the World Bank API. See the method and the full series.

The 5% Pledge, Measured Against the 2% Pledge

Europe has made this promise before. At the 2014 Wales summit, NATO members agreed to spend 2% of GDP on defence within a decade. Our European NATO defence spending tracker — combined military expenditure of the 29 European members divided by their combined GDP, from SIPRI and national accounts data — shows what that decade produced:

• 2014: 1.50%
• 2024: 2.01%

Ten years, +0.51 percentage points. An average of roughly 0.05 points a year. The pledge was met, in aggregate, in the final year available and a decade after it was made.

Now run the same arithmetic forwards. The current target is 5% of GDP by 2035, structured as 3.5% on core defence plus 1.5% on infrastructure and resilience. Only the 3.5% buys hardware from Lockheed, RTX and General Dynamics; the rest is roads, ports, cyber and civil preparedness, and it will not show up in a prime contractor’s backlog.

Getting from 2.01% to 3.5% core defence is a 74% real increase in European defence outlays. Getting to the full 5% headline is a 149% increase. At the 2014–2024 pace of 0.05 points a year, the 3.5% core target arrives around 2053. That is the bear case, and it is not a pessimistic assumption — it is simply the last ten years extended.

But the trend is not linear, and the most recent year is the reason to take the ramp seriously. Between 2023 and 2024 the ratio moved from 1.78% to 2.01% — +0.23 points in a single year, more than four times the decade average. Hold that pace and 3.5% arrives around 2031, and 5% around 2037. That is the bull case, and it is also just data.

So the honest position is a range with a 22-year spread, and every investor in this sector is implicitly taking a view on where inside it we land. The way to update that view is to watch one number annually rather than to read summit communiqués.

Two limitations, stated rather than buried. This is an aggregate ratio — total spending over total GDP — so it weights each country by the size of its economy, and the large, slower-moving economies drag it below the figure you get by averaging national percentages. And it runs on a roughly two-year lag, because SIPRI and national accounts data are finalised late. The 2025 and 2026 acceleration that everyone is quoting is not in this series yet. That is a genuine weakness of the measure, and it is also why the series cannot be talked up: it only moves when the money has actually been spent.

What Converts a Pledge Into a Backlog

Three things sit between a percentage of GDP and revenue at a prime contractor, and each one leaks.

Budget authority is not outlay. A government can authorise spending in one year and disburse it across five. Defence procurement is unusually slow in this respect — long-lead items, multi-year contracts, milestone payments. A headline announcement can be real and still be invisible in cash for three years.

Not all defence spending is procurement. Personnel and operations absorb the majority of most European defence budgets. Countries with conscription-heavy or personnel-heavy force structures can raise the ratio substantially while buying very little new equipment.

Not all procurement is American. European rearmament comes with explicit European industrial policy attached. Rheinmetall, BAE, Thales, Leonardo and Dassault are the intended beneficiaries of a meaningful share of it. The transatlantic capture rate is the variable that turns a European spending number into an LMT or RTX order, and it is being actively legislated downwards.

None of this makes the thesis wrong. It makes the transmission slower and leakier than the headline ratio implies, which is precisely why the backlog figures matter more than the pledges.

Bull Case vs. Bear Case

Bull Case

• Structural demand: The F-35 programme has a 15-year production runway. Revenues are visible and recurring rather than cyclical.
• The ramp is already in the data: European NATO added 0.23 points of GDP in the latest year alone, over four times its ten-year average pace.
• Backlog fortress: RTX’s $268 billion backlog implies roughly three years of revenue visibility regardless of what happens to new orders.

What that supports: continued multiple expansion while the order book grows faster than deliveries.

Bear Case

• Budget reconciliation risk: The $1.5T figure requires Congressional approval. Continuing resolutions delay allocations without changing any headline.
• The ten-year pace: 0.05 points a year is the base rate for European rearmament, and it puts 3.5% in the 2050s.
• Peace premium compression: A Ukraine settlement removes the urgency that justifies front-loaded procurement, even if it does not change the 2035 target.
• Supply chain bottlenecks: Titanium and rare earth constraints cap how fast backlog converts to delivered revenue, which is a margin problem before it is a growth problem.

What that supports: a sector that grows into its multiple slowly, and de-rates sharply on any diplomatic surprise.

We are deliberately not attaching probabilities to these. A precise number on a geopolitical outcome is a rhetorical device, not an estimate, and we would rather show the data that lets you form your own.

Impact Table

WINNING SECTORS	LOSING SECTORS
Aerospace & Defense (LMT, RTX, GD, NOC)	Commercial Aviation (DAL, UAL)
Cybersecurity (CRWD, PANW)	Consumer Discretionary (budget crowding-out)
Satellite & Space (RKLB, LUNR)	Emerging Market ETFs (capital rotation)
AI Defense Tech (PLTR)	Long-duration Bonds (TLT)

Where Capital Moves

Winners: LMT (F-35, Patriot systems, Saudi exposure) | RTX ($268B backlog fortress) | GD (Virginia-class submarines) | NOC (B-21 Raider) | PLTR (AI battlefield intelligence)

Losers: DAL/UAL (route disruptions) | TLT (fiscal expansion pressure) | EEM (capital rotation away)

What’s Next: 3 Catalysts

1. FY2027 Budget Vote (April–June 2026): Congressional markup. Full authorization = major upside for LMT, RTX, GD.
2. Trump-Xi Summit (Late April/May 2026): Delayed from March 31. Taiwan arms and trade tariff outcome is binary for the sector.
3. NATO Summit (June 2026): National spending plans submitted against the 2035 target. The detail that matters is the split between core defence and infrastructure, and how much of the core is earmarked for European suppliers.

What Would Change Our Mind

We would turn more constructive if European NATO’s aggregate ratio posts a second consecutive year above +0.20 points, and if that increase shows up in equipment procurement rather than personnel. That combination would make the 2031 path the base case rather than the optimistic one.

We would turn cautious if the ratio reverts toward its decade average of +0.05, or if European procurement rules tighten enough that the transatlantic capture rate falls materially. In that scenario the pledges remain intact and the American primes still miss.

Both tests run off data we publish and update rather than off a forecast, which is the point.

FAQ

Why are defense stocks outperforming in 2026?

Three simultaneous conflict zones (Ukraine, Middle East, Taiwan Strait) plus NATO’s spending ramp and the largest proposed US defense budget in history have created a demand supercycle. The S&P A&D Index is up +13.51% YTD versus S&P 500 down -1.89%, as of publication.

How much does Europe actually spend on defence right now?

In the latest complete year of data, the 29 European members of NATO spent 2.01% of their combined GDP on defence, up from 1.50% in 2014. The figure is an aggregate — total spending over total GDP — and runs about two years behind because SIPRI and national accounts data are finalised late. We keep it updated on the European NATO defence spending tracker.

Is the NATO 5% target realistic by 2035?

On the pace of the last decade, no — 0.05 percentage points a year puts even the 3.5% core-defence component in the 2050s. On the pace of the most recent year, +0.23 points, 3.5% arrives around 2031 and 5% around 2037. The answer depends entirely on whether the recent acceleration holds, which is why it is worth tracking rather than debating.

Is it too late to buy LMT, RTX, or GD?

The structural tailwind is real and RTX’s $268 billion backlog alone provides roughly three years of revenue visibility. The question is not whether spending rises but how much of it reaches American primes, given that European rearmament comes with European industrial policy attached. Price already reflects a good deal of the optimistic path.

What are the biggest risks?

Congressional budget reconciliation, a Ukraine peace deal compressing the urgency premium, supply chain bottlenecks in titanium and rare earths, and European procurement rules that route spending to European suppliers.

Which defense ETF offers the best exposure?

The iShares U.S. Aerospace & Defense ETF (ITA) and SPDR S&P Aerospace & Defense ETF (XAR) have both significantly outperformed broad indices in 2026 YTD.

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Stay ahead of the markets. — AI Capital Wire Team