While the first quarter of 2026 was marked by persistent concerns about inflation and even stagflation, changing geopolitical developments helped strengthen defense stocks.
The quarter saw a global shift toward industrial rearmament, driven by active conflicts and strategic realignment, which placed continued defense spending in sharp focus. This momentum was further supported by the trend of modernization in defense technology and the emphasis on diverse security partnerships.
Market watchers reacted to the strong earnings, optimistic guidance, record-high backlog and major government contract awards as validation of operating performance.
This combination of geopolitical urgency and the transition toward artificial intelligence (AI)-enabled battlefield systems, drones, and space defense provided a strong tailwind for both traditional aerospace heavyweights and emerging mid-cap innovators at the beginning of the year.
quarter in summary
Conflicting headlines caused market volatility, while earnings updates served as validation for operating performance.
Persistent geopolitical tensions defined Q1. The active conflict and changes in US strategy following President Donald Trump’s Davos address have increased the need for continued defense spending and industrial rearmament. Worldwide in focus.
Large order books from defense contractors reflect higher procurement expenditure, while governments have also emphasized on diversifying defense partnerships as the security landscape evolves. Canada has deepened its relations with EU countries, and EU states have taken steps in this direction. Expand our security partnerships beyond NATO.
Earnings momentum in late January reflected rising orders and backlogs on missile restocking, nuclear modernization and aircraft demand. Defense stocks like Lockheed Martin (NYSE:LMT), RTX (NYSE:RTX), BAE Systems (LSE:BA,OTCPL:BAESF), Rhinemetal (ETR:RHM,OTCPL:RNMBF) and Honeywell International (NASDAQ:HON) saw sharp intraday gains due to volatility from Iran war headlines; However, gains faded as the price of the so-called war premium increased and was then called into question in March.
Modernization and market performance
The Q1 narrative in the defense sector focused on a variety of topics including drones and autonomous systems, missile defense and munition production, naval modernisation, space and satellite defence, cyber security and electronic warfare, AI-enabled battlefield systems and data infrastructure.
The Invesco Aerospace & Defense ETF (ARCA:PPA), a megacap benefiting from exposure to defense contractors, is shown strong growth Among aerospace and defense exchange-traded funds (ETFs), it returned 5.82 per cent in the first quarter.
The State Street SPDR S&P Aerospace & Defense ETF (ARCA:XAR) saw a 5.48 percent increaseDriven by the better performance of mid-cap and small-cap innovators compared to traditional mega-caps.
Analysts noted The XAR will benefit from the shift towards modern defense technology.
The shift toward modernization was reflected in comments from SAP (NYSE:SAP) CEO Christian Klein in March. clean told Bloomberg The defense industry has become the company’s fastest growing business sector amid rising global military budgets. “There is a high demand for better software, better AI to scale businesses,” Klein said.
Government contracts and international cooperation
Amid rising defense spending and trend toward modern defense technology, Q1 saw a handful of Pentagon awards fixed price contract For the main missions of startups in this area.
These include Anduril, which signed a US$20 billion deal with the Army to strengthen the procurement and management of the company’s commercially available technologies, particularly its AI-enabled Lattice suite.
Alphabet (NASDAQ:GOOGL) also announced a collaboration with the U.S. Department of War, providing Department of Defense personnel access to its Gemini Agent Designer feature, which lets users create custom AI agents for unclassified tasks.
Along with this, traditional giants won large-scale industrial orders.
US government honored Lockheed Martin Uncertain contract action worth US$4.7 billion To accelerate production of PAC-3 missile segment enhancements. An outline agreement was signed between the company and the War Department on January 6 as part of the administration’s acquisition transition strategy.
Meanwhile, Canada officially marks a milestone for the country NATO’s 2 percent GDP defense spending target metThe federal government’s defense budget for the 2025–26 fiscal year exceeds C$63 billion. Ahead of this news, the first in-person conversation for the proposed Defense, Security and Resilience Bank (DSRB) happened in montrealCanada is hosting representatives from the 18 founding countries to establish a charter for the new multilateral financial institution.
The purpose of the DSRB is to collect capital to help nations purchase military equipment and to help defense-oriented companies raise capital. The Montreal meeting was the first of three tours focused on the charter, governance and operating procedures.
Following the Defense Financing Roundtable held in February, all of Canada’s major banks, including the Big Six, have expressed support for the initiative. The next meeting is to be held in London in May.
Defense and Security Forecast for Q2
According to Franklin TempletonFinancial conditions remain supportive of risk assets, but “the margin for error is low”, with geopolitical risk contributing to moderate volatility and resulting in an “uneven growth trajectory”.
Despite uncertainty and concerns about valuation levels, liquidity and the possibility of an increase in defaults, credit spreads have remained tight due to significant inflows of capital in recent years.
“Should the trend reverse, we believe there is potential for significant deterioration in credit markets.” Analysts noted that the spread between credit risks and prices is wider within groups such as software or commodity-sensitive names.
Funds seeking more diversified investments may turn to the defense sector. One deep dive first The asset management firm emphasizes that venture-backed players have a “role” to play in shaping the next generation US defense industrial base, as traditional primes increasingly rely on startups for advanced capabilities.
According to, “VC investment in defense will likely remain an important growth area.” S&P Global Data Analyst Yuri StrutaReferencing Anduril’s record-high funding round, which is expected to continue into 2026.
A’s report US$4 billion investment round The round was unveiled in March co-led by Thrive Capital Management and Andreessen Horowitz; However, the deal has not been confirmed.
“Meanwhile, strong stock prices for traditional defense players could fuel a new wave of deals in the defense sector. Incumbents could target promising startups to rapidly expand their technological capabilities.”
While the long-term demand backdrop may remain supportive, near-term performance will likely depend on execution, budget clarity and the speed at which investors receive new evidence supporting existing narratives through earnings, contract awards, policy decisions and export approvals.
Investor Takeaway
Q1 reinforced the defense sector’s position as a focal point for investment. Traditional aerospace giants and emerging innovators had strong market performance in the quarter. Furthermore, the government’s initiative underlines the commitment towards long-term defense financing and partnership diversification.
For investors, the next step is to navigate the transition from narrative to execution.
Q2 performance will likely depend on the pace of contract fulfillment, budget clarity and new evidence supporting existing growth stories through earnings, policy decisions and export approvals.
This sector remains an attractive opportunity for further growth, but success will depend on identifying companies that can effectively translate high-demand signals into strong operating results.
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Securities Disclosure: I, Megan Seiter, do not have any direct investment interest in any of the companies mentioned in this article.
