President Donald Trump's proposal to dramatically increase U.S. military spending has sent defence stocks soaring globally while raising significant concerns about fiscal sustainability. The announcement of a $1.5 trillion defence budget for 2027 represents a substantial jump from current spending levels and has created both opportunities and challenges for the defence sector.

Proposed Budget Increase Details

Trump indicated that the U.S. military budget for 2027 should be set at $1.5 trillion, marking a dramatic increase from the roughly $900 billion approved for the current fiscal year. This proposed expansion would require congressional authorization, though Trump's Republican Party holds narrow majorities in both chambers of Congress and has shown limited resistance to the president's spending priorities.

Moody's Fiscal Deficit Warning

Credit rating agency Moody's has issued a stark warning about the fiscal implications of such a substantial defence spending increase. The agency estimates that this move could significantly add to U.S. debt over the next decade, increasing interest costs and reducing fiscal flexibility. Any jump of the scale proposed by Trump would be difficult to offset through spending cuts or higher revenues elsewhere, given political and policy constraints, even if higher defence outlays provide a short-term boost to economic growth.

U.S. Defence Stock Performance

U.S. defence companies experienced a strong rebound after declining in the previous session, when investor sentiment had been affected by Trump's warning that American contractors could face restrictions on dividends and share buybacks unless they accelerate weapons production. The market response was overwhelmingly positive:

Smaller defence firms also saw strong gains, with Kratos Defense and AeroVironment jumping in double digits. These gains helped companies recover from losses of around 5% experienced the previous day.

European Defence Market Impact

European defence stocks initially extended their rally but later pared gains. The regional aerospace and defence index was up around 1.30% after touching a record high earlier in the session. The sector has surged since Russia's full-scale invasion of Ukraine in 2022, driven by expectations of sustained increases in European defence spending.

Capital Returns and Dividend Concerns

Concerns persist over the future of dividends and buybacks in the U.S. defence sector. Share repurchases are common across the industry, and several large contractors are consistent dividend payers. Analysts estimate that leading U.S. defence firms offer average dividend yields close to 2.00% and have collectively bought back close to 2.00% of their market capitalisation in recent years. While potential curbs on capital returns are seen as negative, analysts believe the overall impact would be manageable given the scale of the proposed budget increase.

Some market participants expect Trump's stance to encourage a rotation towards UK-based defence companies with significant exposure to U.S. contracts, including firms such as BAE Systems and other mid-sized suppliers. Analysts noted that the proposed rise in defence spending could more than offset concerns around potential limits on capital returns, although uncertainty remains over the final size and approval of the budget.

Global markets are positioned to look beyond the US Supreme Court's ruling on Trump's emergency tariffs, with any sustained impact unlikely despite potential short-term market swings, according to Neeraj Seth, Founder and CIO of 3R Investment Management.

Market Outlook on Supreme Court Decision

Seth emphasized that while US markets may experience knee-jerk reactions to the Supreme Court's tariff ruling, the broader market fundamentals suggest limited long-term consequences. Markets are currently monitoring three potential outcomes from the court's decision: partial strike down of tariffs, complete elimination, or no changes to the current structure.

Investors are particularly focused on assessing the timeline for alternative tariff implementations should the ruling favor opponents of the administration's policy. Seth noted that even if the Supreme Court strikes down the current tariffs, the administration retains legal pathways to reintroduce similar measures.

India Market Implications

For Indian markets, Seth anticipates short-term reactions driven by multiple supporting factors:

• Tax cuts implementation
• Expected earnings recovery trajectory
• Reduced tariff-related uncertainty
• Signs of rupee stabilisation

However, he cautioned that trade-related uncertainties connected to global agreements still require resolution before markets can achieve greater stability.

Asset Class Impact Analysis

Seth provided detailed insights on how different asset classes might respond to a potential tariff strike down:

"It's negative for the Treasury markets," Seth explained, pointing to the US fiscal deficit running close to $2.00 trillion. He emphasized that Treasury markets could face particular pressure as tariff revenues have been incorporated into fiscal planning.

Regarding equities, Seth expects mixed reactions across different sectors, with immediate negative pressure possible if long-term yields rise. Interest-rate-sensitive sectors are likely to experience more pronounced impacts compared to other market segments.

2026 Market Volatility Outlook

Looking ahead, Seth expects geopolitical risks to drive higher market volatility throughout the coming year. While global fiscal and monetary conditions remain supportive, he anticipates increased swings in asset prices during 2026, though these fluctuations may not necessarily alter the overall market direction.

The analysis suggests that while short-term market movements are expected following the Supreme Court's decision, the combination of legal alternatives, diluted tariff impacts, and strong underlying market fundamentals should help markets navigate through any immediate disruptions.