Capital Ideas^TM

Russia’s military aggression against Ukraine, which has become Europe’s largest ground war in generations, has impacted millions of people and triggered a large-scale humanitarian crisis as vulnerable Ukrainians take shelter or flee their homes. The intensification and spread of the conflict is deeply troubling and is having a devastating impact on those people caught in the crisis.

This article focuses on potential market and economic implications of the conflict.

Given the inherent difficulty of predicting geopolitical events, one has to plan for a range of outcomes for the U.S. defense complex. Assuming Putin stays in power after this war ends, I believe U.S. defense spending will accelerate from 2% to 3% year-over-year growth to 4%  to 5% year-over-year growth over the next three years.

The U.S. defense budget growth drives U.S. defense stock prices. In addition to better fundamentals ahead, defense stocks are still cheap and consensus estimates could be too low. My belief is that these events will be significantly more impactful for European defense than for the U.S.

Given the full-scale invasion of Ukraine coupled with the reaction from Germany, EU countries generally are taking Russia’s actions seriously. It is not clear how the U.S. government will react as it relates to defense spending, but I think it’s reasonable that we could see 4%–5% growth from current levels, given the need to modernize the force and compete with Russia and China. U.S. defense spending as a percentage of GDP is near all-time lows of 3.2% versus a level of 4%–5% that we have seen during periods of heightened threat levels or war, leaving a lot of headroom for budget growth in the U.S.