U.S. aerospace and defense shares rallied strongly to start 2026, with Boeing jumping nearly 5% and Lockheed Martin adding almost 3% on the first trading day of the year. The gains reflect growing investor confidence in a sector positioned to benefit from unprecedented government spending both at home and abroad.

President Trump has proposed a fiscal 2026 defense budget of $1.01 trillion, marking the first time the Pentagon's budget has crossed the trillion-dollar threshold. The 13.4% increase from the prior year signals an aggressive posture on military spending that defense contractors are eager to capitalize upon.

The Numbers Behind the Boom

The National Defense Authorization Act recently signed into law authorizes over $900 billion in funding for fiscal 2026. This massive appropriation covers everything from personnel costs to advanced weapons systems, with significant allocations for:

  • Next-generation fighters: Billions for the F-35 program and development of sixth-generation aircraft
  • Hypersonic weapons: Accelerated funding for missiles that can evade existing defense systems
  • Space capabilities: Expanded budget for the Space Force and satellite defense systems
  • Naval modernization: Investments in new submarines, destroyers, and carriers
  • Missile defense: Enhanced systems to protect the homeland and forward-deployed forces

The spending surge isn't limited to the United States. European allies, galvanized by ongoing conflicts and security concerns, have embarked on their own rearmament programs.

Europe's €800 Billion Rearmament

The European Union has announced an €800 billion rearmament program, supported by looser fiscal policy and a renewed commitment to collective defense. NATO is now working toward a new 5% of GDP spending target, up dramatically from the 2% threshold that many allies struggled to meet just a few years ago.

Germany exemplifies this shift. The German government plans to increase its defense budget from €86 billion in 2025 to €108.2 billion in 2026, with a target of €225 billion by 2029. For British defense contractors like BAE Systems, these European orders represent a massive opportunity.

"The sector sits at the intersection of two market themes that have been driving flows into January: geopolitical risk and government-backed demand," noted defense industry analysts. "Defense contractors typically draw buyers when investors want revenue visibility, since much of their work is tied to multi-year contracts."

Individual Stock Performance

The defense sector's 2025 performance varied significantly by company, with some contractors dramatically outperforming others:

BAE Systems: The British defense giant rose approximately 63% in 2025, emerging as one of the sector's strongest performers. Analysts at DayTrading.com project continued growth of 5-13% annually, noting that "BAE is enjoying margin improvements and greater cost efficiency as its scale increases." A recent poll of 19 experts showed 14 rating BAE a Buy, 4 a Hold, and just 1 a Sell.

Boeing: After years of struggles related to its commercial aircraft division, Boeing's defense arm has entered a new growth phase. The company won a multibillion-dollar order for F-15EX fighter jets in October 2025, though shares remain roughly 50% below their 2019 highs. The defense business is increasingly viewed as Boeing's stabilizing force while commercial aviation recovers.

Lockheed Martin: Despite its status as the world's largest defense contractor, Lockheed gained just 1% in 2025. The company lost a key contract for next-generation fighter jets to Boeing but maintains a backlog exceeding $170 billion, reflecting long-term visibility from NATO and U.S. modernization programs.

The Investment Case

Bulls on defense stocks point to several compelling factors:

  • Multi-year contracts: Unlike many industries, defense revenue is backed by long-term government commitments that provide exceptional visibility
  • Bipartisan support: Defense spending enjoys rare bipartisan backing in Congress, insulating the sector from political risk
  • International diversification: European rearmament provides a second major growth driver beyond U.S. spending
  • Barriers to entry: The defense industry's complexity and security requirements limit competition from new entrants
  • Dividend stability: Major contractors typically offer attractive dividend yields supported by predictable cash flows

Risks and Considerations

The defense bull case isn't without challenges:

  • Execution risk: Complex weapons programs frequently experience cost overruns and delays
  • Political shifts: While defense spending has bipartisan support today, future administrations could reprioritize budgets
  • Margin pressure: Fixed-price contracts can squeeze profits when costs rise unexpectedly
  • Ethical considerations: Some investors exclude defense companies from their portfolios on moral grounds, limiting the shareholder base
  • Concentration risk: Many defense companies depend heavily on a single customer (the U.S. government), creating potential vulnerability

Looking Ahead

KeyBanc analysts recently identified their top aerospace and defense picks for 2026, focusing on companies with strong backlog growth, margin expansion potential, and exposure to priority programs like hypersonic weapons and space systems.

The sector's near-term outlook appears favorable. With the Pentagon budget at record levels and European allies rushing to rearm, defense contractors face the most supportive spending environment in decades. The question for investors is whether current stock prices already reflect this optimism or whether further upside remains.

The Bottom Line

Defense stocks have entered 2026 with significant momentum, backed by a $1 trillion-plus Pentagon budget and hundreds of billions in European rearmament spending. For investors seeking exposure to government-backed revenue streams in an uncertain economic environment, the defense sector offers compelling characteristics.

However, stock selection matters. The divergent 2025 performance of BAE Systems (+63%) versus Lockheed Martin (+1%) illustrates how company-specific factors—contract wins, execution, and margin trends—can overwhelm sector tailwinds. Investors should focus on contractors positioned to capture the highest-priority programs while managing the operational complexities that can derail even the best-positioned companies.

With geopolitical tensions showing no signs of easing and military budgets continuing to rise, the defense industry's golden era may be just beginning.