Authorised and regulated by the UK’s FCA to provide investment accounts, we are bound by CASS rules to segregate and protect client assets.
Worldwide, defence spending has dropped in recent years, but there are signs that expenditure is beginning rise in certain countries. Nowhere has this been more pronounced than in the US, where President Trump has pledged a 10 per cent increase to US defence spending in 2018 ($639bn in total) – defence was one of the few areas of Trump’s first budget proposal where financing was increased rather than cut (see chart 1). Consistent with his campaign messaging, President Trump has pledged to rebuild the US armed forces, publicly lamenting the structural decline in US defence spending (see chart 2).
Looking in, looking out
Increasing US defence spending has, at times, sat uncomfortably with the indifference to America’s international standing Trump claimed on the campaign trail. Yet in recent weeks, America has launched a missile attack in Syria and dropped a 22,000lb bomb in eastern Afghanistan, suggesting that Trump’s stance will be more in keeping with previous, orthodox, US foreign policy.
While defence is a notable priority of the incumbent President, it is worth mentioning the challenge Trump faces in expanding the military budget, given his competing priorities such as infrastructure stimulus and tax cuts. Furthermore, as Trump has experienced in congressional battles over Obamacare (which he has struggled to repeal), it remains to be seen whether the President will be able to fully deliver on his stated ambitions.
As well as making the case domestically, Trump’s administration has also made noises – and threats – around the low levels of defence spending among allies of the US, notably in Europe. The President’s frustrations are not unfounded in truth – heavily reliant on US protection since the Cold War, many European countries have allowed defence spending to fall over a multi-year time period (see chart 3).
Only five NATO member states currently meet the intergovernmental military alliance’s defence spending target of 2 per cent of GDP (see chart 3), leaving a hypothetical $94bn shortfall. Should the Trump administration continue to threaten the alliance, it may prove more difficult for major economies to avoid a rise in spending, which will be supportive of defence stocks.
Of comfort to the President is the fact that several leaders have already stated their intent to lift defence spending targets to align with NATO requirements – indeed, European defence budgets rose for the first time in six years in 2016. At their frosty first meeting in March of this year, Angela Merkel and Donald Trump discussed military spending, with Merkel committing to reach the 2 per cent target by the end of the decade.
Europe aside, rising geopolitical tensions are creating a further tailwind for the defence sector. In Asia, aggressive posturing has at times threatened to turn into conflict. Of particular note are the territorial disputes around the South China Sea, the 3.5 million square-kilometre waterway (and shipping lane for 30 per cent of global trade) that borders China, Taiwan, Indonesia, Vietnam and the Philippines. Although tensions are merely simmering at this stage, nations in the region have been strengthening their military capabilities, leading IHS Markit to forecast in a recent report that defence spending in Asia will increase to $250bn between 2016 and 2020, from $166bn over the previous four years. In China alone, spending has been growing steadily (see chart 4) and is expected to double over the next 10 years.
The wheels have been set in motion for a meaningful rise in defence spending over the coming years. Global instability may be on the rise, but there are clear opportunities for investors in the sector.