Investors still don't believe in Europe's defense buildup — but they should, Goldman Sachs says
Investors have flocked to European markets in recent months, fueled by the " Sell America" trade and bets that a ramp-up in EU government spending would drive growth.
The enthusiasm sent leading European stock indexes surging — but investors are still not entirely convinced, wrote Goldman Sachs analysts in a Tuesday note.
"Market participants remain skeptical about Europe's ability to increase defence spending in the short term, questioning both the availability of funding and its effectiveness to boost growth," the analysts wrote.
The Stoxx Europe 600 index is up 6.6% so far this year, while Germany's DAX index is up nearly 19% and trading near record highs.
Goldman is even more optimistic. The Wall Street giant expects euro-zone and UK defense spending to rise to 2.7% and 2.5% of GDP, respectively, by 2027 due to geopolitical challenges and the US administration's demands for higher NATO contributions.
In 2024, the EU spent 326 billion euros, or about 1.9% of its GDP, on defense. The UK spent 53.9 billion pounds, or 2.3% of its GDP, on defense that year.
The Goldman analysts added that the region already has a strong industrial base to build on, since 25% of global arms production comes from Germany, France, Italy, Spain, and the UK.
The analysts wrote that they expect most EU countries to ramp up defense spending alongside Germany from 2026, with Italy, Spain, and possibly France tapping the EU's 150 billion euro Security Action for Europe, or SAFE, credit line.
But investors need more to gain more confidence in Europe's industrial turnaround, wrote the analysts.
Specifically, they will need to see real, concrete spending from Germany and the rollout of SAFE.
"Defence spending, because of its capital intensity and focus on R&D, is likely to be an essential element in shifting the narrative," they wrote.
Goldman Sachs' assessment of Europe's defense spending plans comes amid the two-day NATO summit in the Netherlands that started on Tuesday. The allies are expected to announce a commitment to increase defense spending to 3.5% of GDP and another 1.5% of GDP on related infrastructural and cybersecurity.
Defense spending as a share of GDP has fallen since the 1980s to its lowest level in the last decade, when it went below 2%. In 2022 — following Russia's full-scale invasion of Ukraine — military spending started to rise. In comparison, the US spends over 3% of its GDP on defense.
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