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Small U.S. defense stocks surge as demand rises for next-gen battlefield tech

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Smaller U.S. defense companies are delivering standout gains on Wall Street this year, driven by surging demand for low-cost, next-generation military technology designed for modern combat. Global conflicts in Ukraine and Gaza have fueled higher military spending, boosting stocks tied to AI-powered drones, unmanned vehicles, and software-enabled systems that reduce reliance on traditional ground troops.

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

The NYSE Arca Defense Index (.DFII) has climbed about 34% in 2025, far ahead of the S&P 500’s (.SPX) 12% gain. Mid- and small-cap firms lead the rally, including drone makers Kratos Defense (KTOS.O) and AeroVironment (AVAV.O), components supplier Astronics (ATRO.O), and Mercury Systems (MRCY.O). Larger players such as RTX (RTX.N) and Northrop Grumman have also advanced, gaining 37% and 23% respectively.

Policy signals from Washington are shaping the surge. President Donald Trump has proposed renaming the Pentagon to the “Department of War,” while requesting $892.6 billion for fiscal 2026 defense spending, with nearly $6 billion earmarked for unmanned aircraft and counter-drone systems—a 78% jump from last year.

AeroVironment’s growth chief Church Hutton noted the administration’s push to get equipment to U.S. forces faster, a priority echoed by Defense Secretary Pete Hegseth.

Mergers and acquisitions in aerospace and defense are also climbing, though deal values remain modest. Lockheed Martin’s $360 million purchase of Amentum’s Rapid Solutions unit, aimed at expanding radar capabilities, is one recent example. Venture capital has followed suit, with startup funding in the sector hitting $14.17 billion by August, the highest in a decade.

“The demand signal we’re seeing is for tens of thousands of lower-cost munitions systems and unmanned systems,” said Lukas Czinger, CEO of Divergent Technologies, which 3D-prints parts for Lockheed, Raytheon, and others.