European defense stocks are cooling off after the military spending boom. Here's what's next

German Rheinmetall MAN tactical military transport vehicles parked in the Edvard Peperko military barracks. Luka Dakskobler | Lightrocket | Getty Images European defense stocks enjoyed a bumper 2025, fueled by a sharp increase in state military spending targets in response to growing geopolitical instability. This year, however, the sector's fortunes have plateaued somewhat, with the Stoxx Europe Aerospace & Defence index down 1.2% year-to-date, compared with a 4.8% return in the broader Stoxx 600 index. But analysts see 2026 as a period of consolidation for the sector, in which bullishness over Europe's increased defense spending is replaced by greater scrutiny of individual companies' performance and fundamentals. "Investors are becoming very picky and very selective," said Loredana Muharremi, equity analyst at Morningstar. "What investors want to see now are earnings and cash flows, and we believe that we're going to see some upside towards the second part of the year when the orders come, when the down payments from governments come, when the deliveries come — but it will definitely take a while for stock prices to get back to where they were." Shares of defense companies initially held up well after the U.S. and Israel launched attacks on Iran on Feb. 28, as concerns emerged that the conflict would escalate into a full-blown war engulfing the entire Middle East region. But since then, gains for the industry's biggest names have been muted. …