(Bloomberg) -- Analysts at Citigroup are urging investors to buy US defense stocks, even as uncertainty over government plans for military spending clouds the outlook for the policy-sensitive group.
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"We recognize the world order is evolving under the current President, perhaps to a multi-polar one in which three countries control spheres of influence over the Americas, Europe and Asia," Citi analyst Jason Gursky wrote in a Wednesday note to clients.
"However, we don't view that world to be any less dangerous or one that decreases the need to acquire the tools of deterrence," he said, adding that Wall Street's current growth expectations are "too punitive" given the macro backdrop.
The S&P 500 Aerospace and Defense Index is up more than 5% so far this year, outperforming the broader S&P 500. But budget cut worries have hung over the group, and US defense names have struggled to reach their late 2024 highs, even as their European counterparts surge.
Defense Secretary Pete Hegseth last month unveiled a plan to reduce projected military spending by 8% over the next five years. A Pentagon spokesman said earlier this week that initial work by the Department of Government Efficiency, the cost-cutting entity spearheaded by Elon Musk, is expected to yield $80 million in savings - though such cuts represent a tiny amount of the department's budget of about $850 billion.
Still, Gursky doesn't foresee wholesale overhauls to US defense budgets. While the type of equipment the US buys could evolve, the Department of Defense budget remains generous and legacy public defense companies will be forced to innovate, he said.
"Importantly, this spending growth is likely to favor modernization in order to buy deterrence against near peers," Gursky wrote.
Several unknowns remain, including the passage of the 2025 and 2026 fiscal budgets and award announcements from the US and its European allies. Nonetheless, those catalysts are likely to support a mid-single digit growth outlook for the industrial base, compared with Wall Street's pricing, which ranges from a one percent contraction to one percent growth.
"So long as the threat environment remains elevated, and the US plans to continue its leadership role in the world - either as the lone superpower or as a power in a multi-polar world - we expect defense spending to remain robust and for defense company stocks to perform well from current levels," Gursky wrote.