European defence stocks have snapped a two‑year rally as the Stoxx Europe Targeted Defence index slid more than 15% from its January peak, amid tighter budgets. The drop erased billions in market value from heavyweights such as BAE Systems, Rolls‑Royce, Thales, Leonardo and Rheinmetall. The surge that began after Russia’s invasion of Ukraine had lifted the index over 40% annually through 2024.

Investors now doubt how governments will fund programmes. Rising borrowing costs from the Iran‑Israel clash and higher energy bills have swollen fiscal deficits across Europe. Germany will quit the joint fighter jet element of the €100bn Future Combat Air System, and the UK defence secretary resigned, citing “unwillingness” to allocate more resources. State Street data show institutional holders trimming positions as proof of spending remains elusive.

The sell‑off has redirected capital toward high‑tech warfare. Drone maker Parrot is up about 36% year‑to‑date, while Swedish military‑IT specialist MilDef has gained nearly two‑thirds. Analysts say investors now favour companies with a technology tilt, viewing traditional tank‑and‑armor producers as “old economy”. With earnings revisions lagging, the defence rally’s easy money appears spent for the near term.