Defense Sector Surges on Unprecedented Spending and AI Integration

A powerful combination of record-breaking government budgets and a rebounding commercial aerospace industry is fueling significant momentum within the global defense sector. This environment has brought exchange-traded funds like the SPDR® S&P Aerospace & Defense ETF (XAR) into sharp focus for investors. The sector's prospects are underscored by projections that worldwide military expenditures could reach an estimated $2.6 trillion by the end of 2026. A key question for sustained growth is whether technological advancements, particularly in artificial intelligence, can justify and maintain the industry's elevated valuation levels.

Persistent geopolitical instability across multiple regions is creating a sustained, global demand for advanced defense technology. The primary catalyst for sector growth, however, originates from U.S. defense policy. In early January, the U.S. administration proposed a military budget of $1.5 trillion for the 2027 fiscal year. This figure represents a substantial increase from the $901 billion approved for 2026.

This favorable macroeconomic backdrop is generating positive dynamics for the companies held within the XAR ETF. The fund tracks an index that employs a modified equal-weight methodology, allocating 40% each to large-cap and mid-cap stocks, with the remaining 20% directed toward small-cap companies. Its current portfolio of 42 holdings includes industry giants such as Lockheed Martin, alongside more specialized firms like Rocket Lab and Kratos Defense & Security Solutions.

Dual Engines: Commercial Aerospace and Artificial Intelligence

Beyond pure defense spending, a parallel recovery in commercial air travel is providing additional support for the broader aerospace and defense industry. Increased production rates for passenger aircraft and a robust aftermarket services business are lifting financial expectations for 2026, even as supply chain complexities continue to pose operational challenges.

Should investors sell immediately? Or is it worth buying SPDR® S&P Aerospace & Defense ETF?

Strategically, the scaling of artificial intelligence applications represents a major focal point for the sector. After initial testing in pilot programs, AI is poised for deeper integration into critical operational areas by 2026. Prominent use cases include:

• Enhanced battlefield decision-making through automated support systems
• Predictive maintenance to improve fleet readiness and reduce downtime
• Streamlined logistics and resource allocation for greater operational efficiency

Sector Outlook and Key Investor Milestones

The confluence of unprecedented fiscal allocations and rapid technological modernization is constructing a fundamentally constructive environment for aerospace and defense firms. Upcoming quarterly earnings reports will be closely scrutinized to gauge how effectively companies are converting heightened demand into tangible profitability.

For XAR investors, March 2026 marks the next significant calendar event, when the fund's underlying index undergoes its scheduled quarterly rebalancing and reconstitution. Furthermore, market participants will monitor the evolving political negotiations surrounding the final U.S. budget for 2027, as these details will be crucial for validating long-term growth forecasts for the sector's major players.