Smaller U.S. Defense Firms Lead Market Surge Amid Pentagon Shift

Post by : Meena Rani

Smaller U.S. defense firms have emerged as top performers on Wall Street in 2025, driven by growing demand for low-cost, next-generation military technologies. These firms are benefiting from the Pentagon’s pivot toward agile, software-enabled, and easily upgradable combat systems.

Geopolitical conflicts, including wars in Ukraine and Gaza, have fueled global military spending, boosting defense stocks and drawing investor interest in companies specializing in AI-powered drones, unmanned vehicles, and other technologies that reduce reliance on ground troops.

“The winners in this new market will be those companies leaning into the change and investing in low-cost, upgradable, and software-enabled weapon systems,” said Jon Siegmann, managing director at Stifel, covering the aerospace and defense industry.

The NYSE Arca Defense Index has surged about 34% this year, outpacing the S&P 500’s 12% gain. Notably, seven of the top 10 performers on the index are mid- to small-cap firms, including drone makers Kratos Defense and AeroVironment, components maker Astronics, and defense technology company Mercury Systems.

Even legacy operators have posted strong gains. RTX rose roughly 37%, while Northrop Grumman climbed 23%, reflecting broad investor enthusiasm for the sector. “This administration has emphasized the need for warfighters to receive equipment faster,” said Church Hutton, chief growth officer at AeroVironment, noting repeated statements by the U.S. Secretary of Defense regarding accelerated procurement.

Under President Donald Trump, the Department of Defense is being rebranded as the Department of War, pending congressional approval, with a fiscal year 2026 budget request of $892.6 billion emphasizing high-tech missiles and drones while reducing investments in ships and fighter jets. Pentagon allocations include nearly $6 billion for unmanned aircraft systems and counter-drone technology, a 78% increase from the previous year, according to TD Cowen.

“The trends are predictable if you follow government statements — and more importantly, follow the money,” said Richard Safran, senior aerospace and defense analyst at Seaport Research Partners.

Mergers and acquisitions in the U.S. aerospace and defense sector are also on the rise, favoring smaller deals over megadeals. Through September 15, only one of the 56 acquisitions exceeded $12 billion in value, according to Mergermarket. Lockheed Martin’s $360 million acquisition of Amentum’s Rapid Solutions unit highlights a focus on radar and modern battlefield capabilities.

Venture capital is flooding into the sector as well. Lukas Czinger, CEO of Divergent Technologies, noted strong demand for tens of thousands of low-cost munitions and unmanned systems. Startup funding in aerospace and defense has reached at least a decade high, hitting $14.17 billion as of August 9, according to PitchBook data.

The shift toward agile, software-driven, and low-cost military technologies signals a new era for U.S. defense investment, where smaller companies are capturing unprecedented market attention and reshaping the future of warfare.

U.S. defense stocks, Pentagon budget, drones, AI military tech