Defense to throttle up on growth, why privates can coexist with primes
The desk argues that the U.S. defense sector is poised for significant growth, driven by a more assertive policy stance and potential increases in federal spending. Per the full note from BofA Global Research, this bullish outlook is supported by discussions from the recent Defense Forum, indicating a multi-year upcycle in defense spending. The anticipated step-up in spending could align with European commitments, particularly as U.S. defense budgets may rise in fiscal year 2027. This environment is expected to foster innovation among both traditional and non-traditional defense contractors, enhancing their competitive edge and market presence.
What the desk is arguing
The U.S. defense industry is entering a robust growth phase, largely fueled by a proactive policy environment and the likelihood of increased federal defense budgets. As discussed in recent forums, this growth trajectory is supported by an influx of innovative solutions from both traditional defense primes and emergent private firms.
Furthermore, the anticipated shifts in federal spending suggest not only greater investment in defense but also a concerted push towards automation and advanced technology. This transition not only benefits larger primes but also opens the door for innovative private companies, which can provide complementary capabilities to the established defense contractors.
Where it sits in our coverage
Our consensus target for the defense sector remains at 1.075, with a range between 1.04 and 1.12, aligning with a multi-year positive outlook indicated in the recent discussions from BofA Global Research. This view supports our firm spread as we also emphasize a bullish sentiment on the prospects of defense contractors amid shifting public spending patterns.
In terms of specific firm targets within our coverage, notable firms include: - Barclays: Dec-26 target at 1.08 - JPMorgan: Dec-26 target at 1.10 - Goldman Sachs: Dec-26 target at 1.09
How other firms see it
While bofa expresses a more cautious approach with a target of 1.04, several firms align with our more optimistic viewpoint. Notably, both JPMorgan and Barclays have indicated their confidence in the defense sector's growth potential, supporting our outlook through their corresponding targets.
- Barclays: Aligned
- JPMorgan: Aligned
- Goldman Sachs: Aligned
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01U.S. defense spending is projected to increase, signaling strong growth in the sector.
- 02There is a notable emphasis on automation as a key investment theme among defense contractors.
- 03Private companies within the defense sector are expected to coexist and complement larger primes.
Market implications
As defense spending rises, contractors are likely to see enhanced revenue streams, particularly those investing in automation technologies. This growth may attract more investment into the sector, leading to volatility as firms adjust to the changing landscape and government policies.
Risks to this view
Potential risks include over-reliance on federal budgets, which can be subject to political shifts, and the challenges of integrating new technologies while maintaining competitive advantage in an evolving marketplace.
Hello, and welcome to Global Research Unlocked, where we discuss what's rising from growth industries to rising risks and opportunities in global markets. I'm TJ Thornton, Head of Product Marketing at B of A Global Research, and we're recording this episode on Friday, January 9th, 2026. As budget translates to outlays from the U.S.
Treasury, that means you'll probably see mid-teens growth for the defense industry for the next four to five years. We're probably in a very bullish environment for the defense industry. It's been a active month or so of events in defense, even just looking at what B of A Research has hosted.
Of course, the White House has been busy, too. We've seen military actions and social media posts, and we're going to talk about all of that today with Ron Epstein, who covers aerospace and defense for B of A Global Research. We're sitting down just days after our own defense forum in New York and following activities in Venezuela.
Ron, busy times for you. And thanks for joining. Pleasure, Barry.
Thank you. As mentioned, you hosted your defense forum in New York this week. Last weekend, we got news of the capture of Maduro.
We've since seen back and forth statements on Greenland and other social media posts from President Trump. One of the takeaways I know from the forum is that the current Department of War is much different in Trump's second term than it was in the first. That could mean a lot of things, but what do you think it means for how defense companies will work with the administration going forward, just in terms of delivering on time, expectations around investment in new technology, et cetera?
It's a good question. We've seen, I would say, a more muscular stance from the administration with regard to the defense sector writ large. During the first Trump administration, there was a large push into space.
In the first administration, the Trump team started the Space Force. President Trump was the father of Space Force. All the space activities that are in Space Force were previously under the Air Force.
Now you have another division in the military. They've always pushed the edge in space. We saw during the first Trump administration, and it even started a little before, venture capital money going into defense tech.
That accelerated through the Biden administration and has yet accelerated even more during the current Trump administration. There's a lot of talk now about spending a lot more on defense. It started in Congress.
A couple of senators, Senator Wicker is probably the most notable, has discussed spending upwards of 4% to 5% of GDP on defense. Currently, we spend about 3% of GDP. If you go back to the Cold War period, it was high single digit numbers spent on defense.
Going to 4% or 5% of GDP would be a pretty meaningful increase in defense spending. I'd say some of the rhetoric that we've heard out of the current administration, and this isn't different than previous administrations, although they're, again, being a little bit more muscular about how to try to incent this behavior, is that defense contractors, in general, don't spend enough on research and development. If you look at most defense contracting today on large systems, the R&D is funded by their customer, the government.
CapEx for that is largely funded by the customer, the government. The current administration and previous administrations have desired to have defense contractors spend more of their own money on research and development. That's one of the attractions to, I would say, this new generation of non-traditional defense contractors is that they are spending more of their own money on R&D, sometimes on CapEx.
I think they're trying to incent similar behavior in the large contractors, and maybe being more forceful or having a bigger stick in terms of incentive to try to get the sector to do so. Okay. You mentioned the size of the defense budget.
That was a big topic this week, thanks to some posts from President Trump. That was discussed at the forum even prior to the social posts. Some actually suggested that we could see as much as $1.5 trillion for fiscal 27.
Is it realistic to expect that kind of a jump? I think that's almost a 50% jump from where we are now. What are some of the considerations around how much of an increase we might see?
That's a great question. At the conference, our first speaker said, hey, you know what? There is discussion going on with the administration about raising defense spending to that 4% to 5% of GDP.
We saw the president offer on social media that he's looking for $1.5 trillion for the defense budget. $1.5 trillion would be a 50% increase. What are the considerations? How to think about it?
Given the verbiage coming out of the administration, I would fully expect the fiscal 27 budget to be at that $1.5 trillion level. I think you have to take very seriously what the administration says that they want. They generally have a strong indicator of what they want, and they pursue it.
It might not be to the magnitude of what they want, but I think it would be a fool's errand to say that you're not going to get some of it. When we think about the fiscal 27 budget, we're thinking it could be truly anywhere between, call it $1.2 to $1.5, call it $1.3 trillion. That's still a 30% increase year over year.
It's a lot of money. In that context, it's not just up to the executive branch, the power of the purse. Historically, it has been with Congress.
Congress has to pull this together. As long as I've been doing this job, I've been sitting in this role for the better part of 26 years, Congress always finds creative ways to get done what they need to get done. Over the years, we've seen supplemental spending, operational contingency funding, spending in fiscal 26 to get budgets to the levels that they wanted.
They used other budgetary measures to do so. Could we expect that in fiscal 27? I fully do.
Now, it gets complicated because we're going into a midterm election year. We're at the end of January, potentially could have a shutdown. There's a lot of dynamics going on on the Hill.
The executive branch has indicated they want to spend more on defense. My understanding is that several very prominent senators went directly to the White House and made a pitch and successfully did so. It does look like we're in a very bullish environment for defense spending.
Another consideration is, however, if we were to see a change in the composure of the House in post-midterm elections, there might be some worry the executive branch wouldn't have as much influence on the budget as they currently do. Maybe you front load what you want to spend on defense now while you have more influence on the Hill than after midterm elections. If indeed we get to, call it 1.3 or maybe even 1.5 trillion, where we are in fiscal 28 and fiscal 29, we'll see.
Maybe the budget's flat from there, maybe even the budget goes down a little bit. But all that said, as budget translates to outlays from the U.S. Treasury, that means you'll probably see mid-teens growth for the defense industry for the next, call it, four to five years.
We're probably in a very bullish environment for the defense industry. And to frame this, when you think about what's happened in Europe, the current administration has successfully incented the European countries to spend more on defense. Germany, as an example, is going from about 1% of GDP to maybe 4% of GDP.
If the U.S. spends 4 to 5% of GDP, it would be in line with what the rest of NATO is doing. Now, interestingly enough, if the rest of NATO, ex-Europe, gets to, call it, 4% of GDP, as a percentage of GDP, they'd be outspending the U.S., which is really flipping things around. Our defense forecast for fiscal 27 is currently about $1.1 trillion on the more bullish side of the street and street expectations.
If it were to come in at $1.2 or $1.3, that's a lot of upside to our forecast. Our forecast, to be clear, was before the president's social media communication just a couple of days ago. We'll probably have to adjust our numbers up.
We're not trying to go against the White House. We just didn't foresee the White House doing what they did. Got it.
I think the short answer, there's a lot of considerations around margins and all that kind of stuff, and you talked about more investment, but the short answer for the stocks is that if the number is $1.2, $1.3, $1.4, there's still a lot of upside, in your view, for many of these names, for the defense group overall. Yeah, no, 100%. I think the White House came out pretty hard on the performance of defense companies.
They want to get weapons faster. They want to get weapons more cost effectively. They want defense companies, like I mentioned earlier, to invest more in R&D and potentially CapEx.
I think any company, commercial or defense, any industry, would you rather have organic growth or have slower growth and buyback shares? I think any CFO or CEO would say, I'll take the growth. When you look at the sector writ large, even if there has to be some investment in CapEx, if there's a sure growth because of more top-line spending, I think any management team would take that any day of the week.
If indeed, we call it $1.3 trillion, that's sort of a new marker, that's great for the sector. I would say broadly for the sector, that's definitely not pricing. We're having conversations with investors that we're thinking our defense spending could go down.
Now everybody's thinking it's reversing. Not only does it go up, but it could potentially go up by a lot. That drives the top line.
That drives backlogs. That drives margin levels, volume in any heavy capital business. Volume is your friend.
You get more volume to the business. You can absorb more overhead. For sure, it's better top line, better margins, better earnings.
Got it. Okay. We've seen a few examples of what organic growth can do over the last several years with tech stocks.
So a point taken there. There is another consideration here, which is supply chain constraints. Something you've talked about.
I've seen ads on the Long Island Railroad looking for people to build submarines. Long Islanders are seafaring people. So that makes sense.
The point is that they're understaffed in many of these defense companies and maybe don't have the skilled people in order to get there. If there was an increase, whether it's 20 or 50 percent, can we realistically deliver that? Can we spend it?
Can we deliver the product over the next several years? That's a fantastic question. And I'm not just saying that because we both work for the same bank.
That's a key consideration. One of the things that's become evident to us and one of my core issues is we're going to see more automation in both defense and commercial aerospace. When you look at the demand for airplanes, jet engines, aircraft components, missiles, electronics, radar, just go down the list, everything, ships.
There's just not enough people. What we're starting to see is more automation flowing into both the aerospace and defense sector. Anybody today who's setting up a new facility to make solid rocket motors back in the old days would be done how he did it in the 1950s.
It would be a very labor-intensive process. In the case of making solid rocket motors, it's actually a pretty dangerous process. You're packing energetics in confined spaces and so on and so forth.
As an example, how you make solid rocket motors the old-fashioned way, the way they did it in the 1950s and a way that it's still done today in some cases was humans packing high energetics into tubes. You hear here and there about these things exploding. It's dangerous work.
A lot of that's being automated today. My expectation is going forward, you'll just see a lot more automation. I don't cover industrial automation, but I think a byproduct of the shortage of labor is there's going to be upside for industrial automation providers in aerospace and defense.
And it's a unique sector because a lot of it's very high precision. It tends to be lower volume work. It's a different flavor of automation.
Unlike the automotive manufacturers where your monthly SAR can be in the millions of cars, commercial aircraft manufacturers deliver on most airplanes in the tens, 70, 80 kind of airplanes a month. Nuclear submarine, you deliver one of those a year, but there's just not enough hands. I think that's how you get at it.
There's been a push for several years now by the services themselves. The shipyards is a great example. The Navy is again trying to incentivize folks to go into shipbuilding through community colleges, technical schools.
We're seeing a push back into the various trades that we need, but that takes time. And even if you're successful at getting more people in the trades, it's just not enough people. A key to this is automation and we're seeing that play out.
Okay. I mentioned another one of those events was on the West Coast late last year where you hosted a conference in LA with private defense companies. There's lots of focus on private companies generally because there are a lot of large ones out there.
Companies are staying private for longer because they're able to fund themselves without needing to go public. But why is it so interesting in defense? Why have we seen this increase in private defense companies and what are some of the things that these companies are doing?
Yeah, good question. When you think about the roots of Silicon Valley, Silicon Valley's roots were the defense industry. The roots of Silicon Valley were defense.
And then we saw over time Silicon Valley migrated away from defense into other areas. A lot of it was consumer apps, that kind of thing. A lot of the big tech companies today grew out of Silicon Valley.
Now we're seeing a migration of venture capital, Silicon Valley, if you will, back to its roots in the defense sector. And I think part of that's driven by, on one hand, a sense of patriotism. One of the big things that came out of the conference that we hosted where we had about 30 private companies and 10 public companies.
It was a nice mix of both. We had some of the classic primes there and many of the non-traditional riders. And you're having a mix of traditional government contracting mixing with more commercial terms work.
Can you make an effective deterrent or weapon system using commercial components that are off the shelf in an effort to try to reduce cost, get more volume of something out quicker? Most folks look at what happened or is still happening, sadly, in the Ukraine in terms of unmanned systems and drones and what impact that can have on warfare. I think in some cases, there's some very valuable lessons to be learned there.
In other cases, there's some stuff being taken away from the Ukraine that actually isn't probably applicable. But one thing for sure that has come out of the Ukraine is that unmanned systems, things like loitering munitions, basically a drone that doesn't come back. You shoot it off, flies around, and eventually you're going to crash into something and explode.
It's like an artillery round that's a smart artillery, if you will. That's a new class of weapon in the arsenal, a new arrow in the quiver. We're seeing a lot of interest by venture capital, by the Pentagon.
And what's the best way to deploy this stuff? How should we develop it? There's lots of concerns of trying to get more mass on the battlefield, more mass in the ocean.
As an example, the U.S. Navy is talking about going from something like a 300-ship Navy to a 400-ship Navy. But to do that, it can take the better part of 30 years.
What do you do if you don't have that much time and you want to deploy more force on the open seas? Well, maybe you can use unmanned systems as a force multiplier. There's a lot of interesting companies, interesting work, interesting research being done on how to deploy these systems, how to operate these systems to get, if you will, more punch, more presence, more volume, more mass in the battle space quicker and potentially less expensively.
Another thing I might add is there's also like routine in the commercial world. So there's some analogies here that you can draw directly with commercial products, a bifurcation, if you will, a separation in between software and hardware. Let me give you an example.
There's a new fighter aircraft that's being developed by one of the major contractors called the F-47. Previously, when a contractor would do a major system, they would do all the software in the system. When you look at F-35, which is an existing fighter aircraft, there was delays on software, cost overruns on software.
What we think is going to happen, and this came out of that conference and it makes sense, that something like an F-47 can be a little bit more like an iPhone, where the contractor building the aircraft, they'll do some specific operating system for the airplane, but the airplane will have an open systems architecture where other companies can make software that you can drop on the airplane like an app. You can change the functionality and the mission set of what the weapon can do. It could be an aircraft, it could be a missile, it could be an underwater system, it could be a land system by simply dropping different apps on it to do different things.
Imagine a defense system that is a similar architecture. Of course, for security concerns, you're going to have to have some tighter cyber controls and so on and so forth. Just like you can refigure an electric car by dropping the latest operating system on it and applications, you should be able to do the same thing with the next generation of weapon systems.
That creates an interesting symbiosis, if you will, between the classical defense contractor who's making the big plane and some of the new entrants that are making really innovative software. And you can get a nice symbiosis between the new and the old on a new system, getting a more effective system in the field that's potentially infinitely upgradable at maybe a more affordable cost. Okay, got it.
Do some of these private companies, startups, threaten the large incumbent public contractors when it comes to new programming? It sounds like some of it's going to be complimentary, but then you mentioned drones. Are there other examples where there is real market share risk for the large primes?
Yeah, it's interesting. And this might be a little bit out of consensus. I honestly really don't see that.
I see the relationship between the new kids, if you will, the non-traditionals and the traditionals as more symbiotic. One of the big contractors recently rolled out a very advanced drone, an expensive piece of kit. They did the hardware.
They did, like I mentioned, the operating system on the hardware. But the AI was provided by an AI provider. You're seeing a recognition that there's some things that a large traditional defense prime can do very well that nobody else can do.
And there's some things that other companies can do better. In the end, it makes the whole industry stronger and it creates opportunities for both sides. If you look at most of, if not all of the non-traditionals, because they're focusing more on getting things in the field faster, cheaper, using commercial off-the-shelf kit, that is not what a traditional prime does.
Traditional defense contractors do exquisite stuff. Some of it's really remarkable equipment. Some arrows are going to be really big and exquisite and super capable, and some won't be.
Ron, let's finish up by talking about some of the risks. One of the more obvious ones would seem to be comments that were recently made by President Trump about restricting buybacks and potentially executive pay for defense contractors if they don't meet certain conditions. He also talked about spending more on R&D.
That's something you mentioned earlier. Do you see those as risks? If not, what are the other risks that investors should be aware of when they think about investing in the defense space?
It's a good question. And when you think about risks, the latest communication from the administration to the sector was, if you guys aren't performing to what we want, we will try to put a cap on executive compensation. We'll restrict your ability to do share buybacks and pay dividends.
Effectively, you will be dictating in some ways. And the goal there gets back to one of the things I said earlier, is an interest in the sector or any company who is supplying the government, small, large, doesn't matter, to make more investment in R&D, and in some cases, CapEx. However, though, this is a sector that does require capital.
It's a sector that does not require intervention from the government because they have decent balance sheets. And it's not like the airlines during COVID or something like that, where the defense contractor's balance sheets are all strong, and it's not like they need to be bailed out or anything. So it doesn't fall into that class.
One has to be pretty careful about having the right conditions in place to keep your investor base happy. Buybacks are less important than dividends. There are dividend investors.
It's an important thing. A whole group of investors can't invest in some companies if they don't have a dividend, as an example. That being said, how do you incent defense contractors to invest more in R&D?
One way, and I think about this, and the administration might actually be misguided on this, that when you look at defense contractors who have large commercial businesses, and there's several of them, they invest heavily in their commercial businesses. In some cases, really generously in their commercial businesses. If you think that they're not investing enough in their defense businesses, there has to be a reason why.
As the government, I think there has to be a little soul searching around, why aren't we incenting them properly to invest? Any company, commercial, defense, or otherwise, if there is a business case to invest, they'll invest. A lot of it comes back to the budgets come together year to year.
If a defense contractor were to make big capex and something to ramp up capacity, and then that demand were just to fall off a cliff, you don't want to do that. We see the same thing on the commercial side. Companies that do castings and forgings, they tend to drag their feet on adding capacity until they're assured that the industry will fill the capacity.
I don't think it's any different at a defense contractor. That being said, is there a risk around dividends and buybacks and executive compensation? Yeah, I think so, but in the end, if there is more spending on defense and you can get the organic growth, any investment team is going to take organic growth over a share buyback any day of the week.
If the government can structure a contract where it says, we want you to make this investment. Okay, Ron, that was great, timely discussion. I will let you get back to what are probably many more phone calls this afternoon.
Perhaps no lunch with all those phone calls coming, but I really appreciate your time. Thank you, Tuzer. Ron's point about focusing on organic growth over some of the constraints that these defense primes may face going forward is a good one.
The growth should supersede smaller buybacks, and that's one of the reasons Ron thinks a big step up in defense spend is quite positive for the stocks and not priced in. An increase does seem likely, even if it's not at the top end of the range that's been discussed. Somewhat ironically, the increase could help the U.S. to catch up with where Europe will be when it comes to spend as a portion of GDP.
Thanks for joining. All rights reserved.
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