Following the strong performances recorded in 2024 and 2025, defense stocks had become a market consensus. However, the reversal is stark: according to Tikehau Capital, hedge funds' long positions in the sector have approximately halved from $23bn to $12bn, while short positions have reached over 4% of the free float, their highest level since the EU-NATO summit in February 2025. Simply put? Many investors have merely taken profits after a spectacular rally in share prices.

"Defense stocks were overvalued for the most part, and one must always be wary of market fads," recently analyzed Christopher Dembik, Investment Strategy Advisor at Pictet AM. "Everyone wanted to rush into this sector on the stock market, sometimes without understanding the fundamentals, the importance of public procurement, and the cyclicality. This does not mean one should not invest, but one must know how to take profits in time."

Military budgets: victims of political warfare

Market participants are also concerned about the ability of European states to maintain such a significant budgetary effort over the long term. This is especially true as economic indicators are not reassuring, amid sluggish growth, high deficits, and rising energy costs...

Beyond financial capacity, Europe's political will to build its military sovereignty can be questioned, especially when observing that many European countries continue to source heavily from Uncle Sam, to the detriment of their European counterparts.

In France, the recent blocking of the French Military Programming Law in the Senate also illustrates the political hurdles that remain to be overcome to reassure investors. Indeed, last week, the request for a global budget extension of €50bn through 2030 suffered a serious setback, falling victim to the warfare - this time political - waged by elected officials.

Demanding markets and disruptive drones

Investors are also paying closer attention to operational execution. In a context of high valuations, the slightest delivery delay or earnings disappointment is more severely penalized.

The case of Rheinmetall illustrates this new exigency. The German group published Q4 2025 results slightly below expectations, and its stock has lost 22% YTD, despite a fundamentally favorable environment.

Furthermore, the rise of drones and autonomous systems calls into question traditional models of land warfare: today, a drone costing a few thousand euros can destroy a tank or armored vehicle worth 1,000 times its price.

Consequently, groups most exposed to traditional heavy equipment no longer automatically benefit from the same premium as players positioned in new defense technologies.

Fundamentals remain solid

Despite this stockmarket stall, industrial indicators remain impressive. France plans €413bn in military spending under the 2024-2030 Military Programming Law. In Germany, the defense budget could reach €145bn in 2027, a 21% increase compared to the previous level.

Most importantly, order books continue to hit record highs: €73bn in orders for Rheinmetall, nearly €57bn for Leonardo, €53bn for Thales, and €46.5bn for Dassault Aviation.

Tikehau analysts thus point to a near-continuous growth in order books between 2023 and Q1 2026 for all major European players in the sector.

A pause rather than a reversal?

Thus, the current correction looks more like a digestion phase than a challenge to the investment thesis. European rearmament responds not only to several decades of underinvestment but also to the American disengagement from Europe. Washington's expansionist aims toward European territory such as Greenland also reminded Europe of the necessity to ensure its own defense.

This US/Europe fracture is felt in the markets: investors no longer treat defense as a homogeneous bloc but are increasingly discriminating between players based on their geography, technological exposure, execution quality, and ability to convert orders into profitable growth.