Quietly leading the market's military stocks

With only two weeks left until the US presidential election, we previously introduced the lesser-known defense stocks in the "Trump trade beneficiary stocks, global arms suppliers" article, which are the most direct potential beneficiaries of the Trump trade.

In the past three months, overseas defense stocks have been hitting new highs. For example, the three Japanese defense stocks we mentioned before, Mitsubishi Heavy Industries (7011.JP), Kawasaki Heavy Industries (7012.JP), and IHI Ishikawajima-Harima Heavy Industries (7013.JP). Since the sharp drop in Japanese stocks' carry trade in early August, IHI has risen by nearly 60%, Mitsubishi Heavy Industries by nearly 40%, and Kawasaki Heavy Industries by nearly 30%.

In addition to the three Japanese stocks, defense stocks in other overseas markets are also leading the market, with individual stock gains even surpassing tech stocks this year, making it an interesting new phenomenon in the global stock market.

I. Trump trade gradually coming true, soaring defense stocks

Previously, foreign investors priced defense stocks based on the logic that a Trump victory would push countries to increase defense spending to reduce US military spending, so Trump's approval rating was seen as a positive catalyst for defense stocks. Similarly, the market was concerned that if Trump did not win, it would be negative for defense stocks, as the narrative of countries increasing defense spending would not hold.

However, based on recent trends, the correlation between Trump's approval rating and defense stock prices is becoming weaker. In other words, regardless of whether Trump wins or not, the trend of countries increasing defense spending has become a market consensus.

Looking back over the past three months, although Trump's approval rating soared after the shooting incident, there were still periods of lagging behind. When looking at defense stocks that are highly correlated with Trump's approval rating, it is evident that defense stocks are not affected by changes in approval ratings and will continue to rise, while stocks related to the Trump trade are still heavily influenced by approval ratings.

For example, IHI in the Japanese stock market has risen by over 50% since early August, while GEO, a private prison stock related to the Trump trade, has only risen by 15%, and the XAR S&P Aerospace & Defense ETF has also risen by 11%.

Looking at the largest holding in the US XAR ETF, AXON, which has risen by over 70% year-to-date; another US company, Raytheon Technologies (RTX), has also risen by over 50% year-to-date; General Electric (GE) Aerospace, which makes military aircraft engines, has risen by over 70% year-to-date; Hanwha Aerospace in the South Korean stock market has risen by over 200% year-to-date, and IHI in the Japanese stock market has risen by over 180% year-to-date The main military stocks of US, Japan, and South Korea have outperformed the majority of the market.

The reason for the increasingly strong performance of military stocks in various countries is that more and more countries have increased their military expenditure budgets for next year in the second half of the year.

For example, Japan revealed in August that its military expenditure for 2025 will be 85 trillion yen, an increase from this year's 79.5 trillion yen; the budget for next year has grown by nearly 2 trillion yen from 68 trillion yen in 23, and by nearly 3 trillion yen from 54 trillion yen in 22.

In just 3 years, the military budget has increased by half, and the market expects military spending in 27 to reach 11 trillion yen, doubling from 22, which explains the rise in Japanese military stocks.

Moreover, since last year, military spending in G7 and NATO countries has been significantly increased. According to statistics, since 2015, military spending in NATO countries has been increasing. Among the 32 NATO member countries, 23 countries have raised their military spending to 2% of their GDP this year, with NATO's total military spending increasing by 18% from last year.

When most member countries increase military spending, the remaining countries will also be forced to increase to 2% of their GDP. Japan, for example, follows this practice, increasing military spending to around 2% of GDP each year while maintaining economic growth.

Although the decline in Trump's approval rating had little impact on military stocks, a potential positive impact on military stocks is expected if Trump wins. This effect is particularly significant for US and Japanese military stocks.

II. Growing Weapon Orders

In the previous article, we introduced that the main businesses of 7011/7012/7013 in Japan are government orders. Due to the Japanese government's amendment of weapon export regulations in the past two years, these 3 major Japanese heavy industry stocks can export weapons to other countries, and the Japanese government will subsidize weapon manufacturers, increasing the profit margin from government orders from 8% to a maximum of 15%. This has brought new growth logic for these 3 companies, which already have weapon orders from the US, Italy, and the UK.

Looking at the increase in military spending in Japan and NATO countries to 2% may not seem very intuitive, but from a corporate perspective, this represents a significant boost for military enterprises. For example, after the Japanese government increased military spending in 22, the amount of orders from the government to military enterprises has grown several times. For example, the three largest heavy industry stocks, Mitsubishi Heavy Industries (7011.JP), received a 4.6-fold increase in government orders in 23 years, while Kawasaki Heavy Industries (7012.JP) grew by 2.3 times, and IHI (7013.JP) saw a 4.3-fold increase in government orders. In 2022, the Japanese government's procurement amount was ¥1.7226 trillion, which increased to ¥5.5736 trillion in 2023.

According to Japanese defense procurement order data, Mitsubishi Heavy Industries secured 30% of the procurement order amount in 2023, Kawasaki Heavy Industries only secured 7%, and IHI only secured 2.3%.

The reason Mitsubishi Heavy Industries can secure a large portion of the order amount is that the largest shareholder is the Japanese government. Additionally, Mitsubishi Heavy Industries is endorsed by Mitsubishi Corporation, which sets it apart from IHI and Kawasaki Heavy Industries in terms of qualifications.

Looking at the shareholder details, the largest shareholder of Mitsubishi Heavy Industries is Japan Bank with a 15.4% stake, followed by another Japan Bank with a 6.1% stake. The remaining major shareholders are mainly insurance institutions, banks, and foreign financial institutions.

As a result, foreign investors tend to value Mitsubishi Heavy Industries higher than 7012/7013. Mitsubishi Heavy Industries is valued between 20-25 times, while Kawasaki Heavy Industries/IHI are maintained within 10-15 times PE.

It is worth noting that as Japan's military spending continues to expand, Mitsubishi Heavy Industries cannot consume all the additional military expenditure alone. Therefore, the market is looking at the valuation still around 10 times PE for Kawasaki Heavy Industries/IHI, compared to over 20 times for Mitsubishi Heavy Industries, these two also have the opportunity for valuation expansion.

For example, as shown in the chart below, with the expansion of military spending, Kawasaki Heavy Industries and IHI only received orders of ¥169.2 billion and ¥29.1 billion in 22, respectively. In 23, the amounts for these two companies expanded to ¥388.6 billion and ¥125.7 billion, respectively.

In the newly disclosed 2025 military budget in August this year, it was mentioned that there will be additions of drones and satellite-related equipment, bringing new orders to IHI. This has led to IHI's stock price outperforming Mitsubishi Heavy Industries and Kawasaki Heavy Industries.

Furthermore, the recent appointment of Japan's new Prime Minister, Shigeru Ishiba, has brought new stimulus to defense stocks. Firstly, as he was previously the Japanese Defense Minister and has always advocated for increasing Japan's military spending, as well as pushing for Japanese companies to help the United States in repairing fighter jets and maintaining weapons for other countries, which will bring more orders to Japanese heavy industries.

Secondly, after his appointment, there may be an increase in the export prices of Japanese weapons, as the yen has depreciated again, expanding market expectations for these three defense stocks.

Conclusion

Similarly, apart from these three Japanese companies, defense stocks in the US are also thriving, far outperforming the market. Companies such as GE, RTX Raytheon, Lockheed Martin, AXON, and others, mainly engaged in fighter jet engines or fighter jet components.

Regardless of whether Trump wins or not, the gradual increase in defense spending by G7 and NATO countries to 2% of GDP is already a major trend. In this situation, it is not difficult to understand why gold prices have been rising steadily, as geopolitical tensions remain high