Defense stocks drop as Democrats' midterm sweep clouds U.S. spending outlook

Midterm outcome knocks a hot trade

Defense shares on both sides of the Atlantic pulled back after Democrats won big in the US midterms, undercutting the case for an even larger ramp in US military outlays. Lockheed Martin and Northrop Grumman each fell more than 3% before the open.

In Europe, a Goldman Sachs Group gauge of defense contractors dropped as much as 4.1% on Wednesday, the sharpest fall in over four months. BAE Systems slid up to 5.9% and gets close to half of its revenue from the US. By early morning, Asian exchanges had already closed.

These moves followed a strong run into 2026, powered by geopolitical tensions and global plans to lift defense budgets. In the US, President Donald Trump had called for $1.5 trillion in military spending for the budget year that ends in 2027. Since then, the group has whipsawed as investors started positioning for a big Democratic win, a scenario that could bring stricter oversight and delay funding.

Policy signals and the Iran backdrop

Keith Lerner, who is the chief investment officer for Truist Advisory Solutions, said there are now "some more open questions about the path forward for the defense budget." He also pointed to questions around "the various wars that are outstanding, whether there will be any pullback relative to if there wasn't a shift in the composition of Congress."

On Tuesday, Trump told the Financial Times he did not plan to order strikes on Iran immediately after the midterms. Earlier this week, Trump and officials including Vice President JD Vance sounded somewhat more dovish on prospects for a peace deal, which pushed oil lower, though tensions between the sides remain elevated.

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In a Wednesday note, TD Cowen's Roman Schweizer wrote that a "Democratic sweep is clearly the toughest outcome for defense spending," adding that "the magnitude of it could go well beyond spending and impact national security and foreign policy into and beyond." He anticipates the next Congress will stage a vote designed to compel Trump to bring an end to the war in Iran, and added that it is now "more conceivable" that enough Republicans could support overriding a presidential veto. He also said the lame duck period before membership changes "becomes very important very quickly" as lawmakers seek to advance a baseline defense budget along with supplemental funds via an expedited process.

Europe's setup and what funding likely holds

Jens-Peter Rieck at Mwb Research said last year's European defense rally was helped when the US under Trump scaled back its security commitment to the region, spurring European governments to step up spending. With the election results, he said the "US walks away from Europe scare" that fueled the sector's 2025 surge is off the table. He called the midterm outcome a "mild negative for sentiment on German defense stocks," with bigger moves possible Thursday when Hensoldt, Rheinmetall and Renk report third quarter results.

Mediobanca's Alessandro Pozzi said Europe's move was somewhat surprising because polls and prediction markets had indicated a Democratic sweep for weeks. He noted "There is a broader bipartisan support for key air and missile defense programs, the Golden Dome and shipbuilding, although funding remains subject to the political debate."

Some investors had been trading volatility in US defense names into the vote, betting Democrats would still back spending to replenish munitions run down during the Iran war. And core lines may stay intact: "The bulk of the defense budget is set in stone," said Mark Malek, who serves as Siebert Financial's chief investment officer. "Missile replenishment is not likely to be hampered by political ideology. Similarly, next-gen defense tech is universally accepted as necessary for not just its efficacy but also its budget efficiency."

What it means for your portfolio

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