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Akbar Novruz

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No period is more disconcerting to witness in financial markets than during times of conflict. The minute a missile strikes anywhere in the world, financial markets start adjusting not just losses but opportunities as well. It is a process that is uncomfortable to witness even for those who believe in the value-neutral role of financial markets. It is a process that is being witnessed again in the American-Israeli war against Iran.

On March 2, a day after the start of Operation Epic Fury, Northrop Grumman rose by 6 percent, RTX by 4.7 percent, L3Harris by 3.8 percent, Lockheed Martin by 3.3 percent, and Boeing by 2 percent. Similarly, shares in Palantir Technologies, whose government segment recorded $1.9 billion in revenue in 2025, a rise of 55 percent from a year earlier, rose by 5.8 percent. Lockheed Martin, RTX, and Northrop recorded a 52-week high on this day as well. In contrast, the S&P 500 index recorded losses and ended the day flat.

Defense contractors have lobbied Washington for about $191 million in 2025, with Iran-related policies, spending appropriations, and the Trump administration's focus on weapon procurement as key drivers. RTX, Lockheed Martin, Boeing, Northrop Grumman, and L3Harris are the biggest spenders in defense contracting.

The financial situation also helped fuel the optimism. The defense budget for fiscal year 2025 included $858.9 billion for the Pentagon budget, $10.6 billion more than the administration requested. The budget for fiscal year 2026 included about $1.3 billion for industrial supply chain improvements and $2.5 billion for missile spending, with RTX set to benefit. The Trump administration indicated a desire for much larger figures. Given this environment, the initial run in defense stocks can be seen as rational, as they were based on a real environment in which military spending and munitions use were high.

Modern financial history offers a consistent lesson that is consistently ignored at the start of each new conflict. When war remains limited and bounded, the logic holds: orders increase, earnings improve, and shares respond accordingly. But when conflict escalates into something larger and more sustained, governments have a persistent habit of reclaiming the gains.

During both world wars, the British government imposed high excess-profits taxes on arms manufacturers. After the United States fully entered World War II, it repeatedly renegotiated and reduced prices on contracts already signed, a practice that continued through Korea and the Cold War. Research cited by The Economist found that from 1938 to the attack on Pearl Harbor, US aircraft manufacturers' shares performed strongly. From late 1941 through 1945, the broader US market outpaced defense stocks. The larger the war became, the less governments tolerated corporate windfalls from national emergency.

The current environment is already showing traces of that pattern. In January, President Trump issued an executive order barring defense contractors from paying dividends or buying back shares, and signalled that CEO pay at defense companies should be capped at approximately $5 million per year. Whatever the eventual legal reach of these measures, the direction of travel is clear: when national security takes priority, market logic takes second place.

Part of what makes the current moment unusual is that defense stocks were already elevated before Operation Epic Fury began. The iShares US Aerospace and Defense ETF had returned more than 11 percent in the year to date even as the S&P 500 slid roughly 1 percent. The Global X Defense Tech ETF had returned 72.8 percent in the twelve months to February 27, against 37.4 percent for the S&P 500 over the same period. Western defense stocks are now trading at around 35 times expected earnings, a valuation level not far from Nvidia at the peak of the AI boom.

That premium matters enormously for how the Iran war intersects with investor returns. Rotation into defensive sectors had already occurred before the escalation, driven by concerns about AI valuations and broader market uncertainty. Traditional safe-haven sectors, consumer staples, healthcare entered the crisis looking expensive and performed poorly: major ETFs focused on healthcare and consumer staples declined 5 to 6 percent, while tech stocks dropped less than 1 percent over the same period. The conventional playbook of rotating into defensives during geopolitical shocks produced negative returns, because the rotation had largely happened already.

For defense specifically, the question is now less whether governments want more weapon, they demonstrably do, and more whether the profit from producing those weapons will accrue to shareholders or be captured by the state through pricing controls, profit caps, and renegotiated contracts. History offers a clear answer to that question: the more urgent the national need, the smaller the margin left for investors.

South Korea's defense industry has been one of the more remarkable industrial stories of the past four years, and the Iran war has renewed attention to whether that story still has further to run. The numbers are striking. South Korea's four largest defense companies, Hanwha Aerospace, LIG Nex1, Korea Aerospace Industries, and Hyundai Rotem, are projected to surpass 40.9 trillion won ($28.45 billion) in combined sales for 2025, up more than 80 percent from 2024 and more than triple their 2021 figures. Operating profits have risen more than tenfold over the same four-year period. Hanwha Aerospace alone reported a record operating profit of 1.43 trillion won in the first half of 2025, four times what it was a year earlier. The combined order backlog for the sector has now surpassed 100 trillion won ($72 billion), securing production lines for the next four to five years.

The growth has been driven by European rearmament in the wake of Russia's invasion of Ukraine, combined with South Korea's ability to deliver NATO-standard equipment quickly and at competitive cost. South Korean arms sales to Europe hit $12.55 billion in 2022 and $11.03 billion in 2025, with landmark deals including Hyundai Rotem's second K2 tank contract with Poland worth approximately 9 trillion won, Hanwha's $4 billion Chunmoo guided missile contract signed in December 2025, and LIG Nex1's Cheongung-II air defense contracts across the Middle East. By 2025, South Korea had tied with France for second place in weapons exports to NATO member countries, with a 6.5 percent share.

Beyond the defense sector, the Iran war has produced a revealing shift in how capital is moving. Energy stocks have risen as expected, with West Texas Intermediate crude surging sharply on fears of Hormuz disruption. But the more notable development is the resilience of technology. Tech stocks have dropped less than 1 percent since the escalation, significantly outperforming traditional defensive sectors, partly because the sector entered the crisis at a discount after earlier fears about AI valuations, and partly because technology companies like Palantir and CrowdStrike are themselves increasingly embedded in defence operations, straddling the line between civilian and military revenue.

The S&P 500 is down nearly 3 percent for the year, but markets have recovered their losses within six months of the start of a war roughly 72 percent of the time since World War II. That statistical resilience is real, but it conceals considerable variation, and it says nothing about which sectors lead the recovery.

The right framework for thinking about defense stocks in the current environment is not optimism or pessimism, it is specificity. The broad thesis that war equals defense upside is too crude to be useful. What matters is the nature of the conflict, the degree of government intervention in pricing and profit, the valuation already embedded in share prices, and the operational capacity of individual companies to execute at scale.

South Korean defense companies have demonstrated genuine global competitiveness. European rearmament is a structural trend with years of momentum behind it. The Iran conflict is generating real munitions consumption and real demand for replenishment. None of that is in dispute.

What history disputes is the investor reflex that translates national emergency into an automatic shareholder windfall. The larger the conflict becomes, the more governments reclaim from markets. The higher the valuations already embedded in defense stocks, the less room there is for further upside even when the underlying demand is real. War can drive revenues. It does not, in the end, guarantee returns. When national security comes first, corporate profits are rarely far behind in the queue of things that get managed in the public interest.

*Market data sourced from Air & Space Forces Magazine, SIPRI, WSJ and open financial reporting.