Defense stocks may see long-term lift as Russia's actions spur big jump in spending by U.S. allies

Published Tue, Mar 1 20223:37 PM EST

With financial markets in turmoil amid war between Russia and Ukraine , defense stocks have outperformed — and Wall Street expects the trend to continue. Russian forces on Thursday invaded Ukraine . The conflict should boost defense stocks in the long term as spending in the space is set to increase, according to analysts. "As we think about the events that unfolded last week in Eastern Europe, there has been a tectonic shift in geopolitical stability," Bank of America's Ronald Epstein said in a note Tuesday. "Europe has not seen anything like this since WWII and the U.S. and its NATO allies now have to focus on managing escalation along Russian borders." Bank of America expects defense spending to rise to at least 3.5% to 4% of U.S. gross domestic product "on the paradigm shift." The U.S. budget could grow by a mid-single-digit, which would be "positive for defense stocks long-term," said Bernstein's Douglas Harned. "With geopolitical tensions likely to remain high, we expect many countries (both inside & outside of NATO) to look to fortify their military capabilities and increase defense budgets on a secular basis," Wolfe Research's Chris Senyek said in a Tuesday note. Bank of America projects NATO's "soft target" of defense spending at 2% of GDP to become a "'firm' target or floor." Germany on Sunday already announced it would ramp up defense spending above 2% of GDP. The SPDR S & P Aerospace & Defense ETF is up more than 7% over the past week while the S & P 500 is little changed over the period. Lockheed Martin was among the top gainers on the S & P 500 on Tuesday. As defense spending increases, the multiples of defense stocks should expand, according to Bank of America. The firm expects defense stocks to move from a 20% to 30% discount to the market to a 20% to 30% premium. "In a rising defense budget environment, defense stock multiples should typically rise," said Epstein. Take look at some of these analysts' top picks for defense stocks. L3Harris was among the top defense stocks chosen by both BofA and Bernstein. The company makes command-and-control systems and products, wireless equipment, electronic systems, and more. General Dynamics is one of Bank of America's favorite defense stocks. "GD's defense program exposure, especially in its Marine unit, coupled with Gulfstream could provide near-term and medium-term organic growth." Epstein said. Bernstein highlighted Northrop Grumman' s position with nuclear. "We like Northrop Grumman's position with two of the three legs of the nuclear triad," Harned said. "With Putin's language regarding Russia's nuclear arsenal, we expect Congressional support for these programs to be reinforced." Other defense names highlighted by the firms include Raytheon and Lockheed Martin . —CNBC's Michael Bloom contributed to this report.

Northrop F-5 Freedom Fighters of the Turkish Air Force aerobatic demonstration team.

Adem Altan | AFP | Getty Images

With financial markets in turmoil amid war between Russia and Ukraine, defense stocks have outperformed — and Wall Street expects the trend to continue.