European defense stocks came under pressure on Tuesday after Morgan Stanley lowered its view on the sector to “Equal Weight” from “Overweight”, bringing an end to the bank’s extended positive stance on the industry.
The investment bank pointed to a shortage of near-term catalysts, weakening factor momentum and the possibility that progress in ceasefire discussions between Russia and Ukraine could dampen investor enthusiasm for defense-related stocks.
“For now, we are taking a wait-and-see approach due to a relative lack of material catalysts, attenuated factor metrics, and our belief that meaningful ceasefire negotiations between Russia and Ukraine could be on the horizon,” said the strategists led by Marina Zavolock.
The downgrade weighed on defense names across Europe. Spanish defense technology group Indra (BIT:1IDR) recorded one of the steepest declines, falling around 4%, while Rheinmetall (TG:RHM), Dassault Aviation (EU:DSY) and Hensoldt (TG:HAG) also traded lower.
According to Morgan Stanley, the sector dropped from fifth to fourteenth place within its 30-industry ranking model. The bank highlighted a sharp deterioration in idiosyncratic momentum, which fell to the 24th percentile from the 62nd percentile previously, alongside a notable slowdown in positive analyst target-price revisions.
Despite the downgrade, Morgan Stanley’s defense analysts continue to see long-term value in the sector. They noted that valuations have returned to around 17 times estimated 2028 earnings, roughly in line with levels seen in February 2025 when NATO’s 2% of GDP defense spending target remained the benchmark. The analysts also pointed to several potential catalysts, including the Eurosatory defense exhibition later this month, the NATO Summit in early July and upcoming first-half earnings reports.
“We recognize that our downgrade comes after a significant decline in performance since the beginning of the year,” the strategists said.
AI and Metals Gain Favor in Latest Sector Review
The defense downgrade formed part of Morgan Stanley’s broader quarterly sector allocation review, in which the bank increased its preference for European companies benefiting from artificial intelligence trends following recent market weakness.
Semiconductors retained the top position in the bank’s rankings, supported by an improved overall score. Metals and Mining was upgraded to “overweight” from “equal-weight”, climbing from ninth to second place.
Morgan Stanley cited several supportive factors for the mining sector, including supply disruptions in copper production, resilient Chinese demand, growing AI-related demand for metals and a constructive outlook for gold.
Capital Goods was also upgraded to “overweight”, driven largely by AI-linked investment themes. Siemens Energy regained the number one position among approximately 400 companies included in Morgan Stanley’s combined screening model.
The banking sector improved from sixth to third place while maintaining its “overweight” rating, supported by stronger profitability, efficiency gains linked to artificial intelligence and attractive valuations.
At the other end of the spectrum, Morgan Stanley downgraded both Life Sciences and MedTech to “underweight” from “equal-weight”. The bank cited weaker earnings revisions, narrowing target-price ranges and a lack of standout market leaders as reasons for the more cautious stance.
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