Defense giants say investors should still bet on them, as hopes for a Russia-Ukraine peace deal spark a selloff

Some of Europe’s biggest military contractors urged investors not to cash out of the sector on Tuesday, as stocks sold off on hopes of a peace deal between Russia and Ukraine.

President Donald Trump’s special envoy Steve Witkoff and his son-in-law Jared Kushner joined peace talks with Ukrainian President Volodymyr Zelenskyy in Berlin over the weekend. Zelenskyy said during the talks that Kyiv was willing to give up its NATO membership ambitions in order to secure a deal to end the war.

American officials then told reporters a peace deal was close to completion, while U.S. President Donald Trump said negotiators were “closer now than we have been ever” to stopping the conflict. Talks are expected to continue into the weekend.

European defense stocks sold off on Tuesday as investors weighed the news, with some big names extending losses from the previous day. By 11:40 a.m. in London (6:40 a.m. ET), the regional Stoxx Aerospace and Defense index was trading 2.2% lower, with Swedish fighter jet maker Saab leading losses on a 5.2% fall. Italy’s Leonardo, down 4.7%, and Germany’s Rheinmetall, last seen 4.5% lower, were also among those seeing the biggest declines.

A spokesperson for German defense prime Hensoldt said the company hopes for “a just and lasting peace for Ukraine,” but added that, even if this is achieved, Europe remains under threat of attack.

“A cessation of hostilities would give Russia the opportunity to reconstitute its military capabilities. From a European security perspective, the underlying threat remains and could even intensify,” they said.

“Against this backdrop, defense readiness continues to be a structural necessity for Europe,” they added.

Hensoldt’s representative said the company’s business exposure to Ukraine is limited, accounting for a single-digit percentage of revenues. The company’s stock, which has more than doubled in value this year, was last trading 4.6% lower.

“Our growth trajectory is primarily driven by large, long-term programs in Germany and across Europe,” the spokesperson told CNBC on Tuesday morning, pointing to a three-digit-million-euro contract to equip the German armed forces’ reconnaissance vehicles with software and advanced sensors, and projects under the European Sky Shield Initiative.

Many of the firm’s contracts will continue “in 2026 and beyond,” they added.

A representative for German vehicle systems manufacturer Renk – a contractor to more than 70 armies across the globe – acknowledged “an elevated level of volatility” in European defense stocks “anytime there is news surrounding a potential peace deal or ceasefire in Ukraine.”

They added: “While we would very much welcome peace in Ukraine for the Ukrainian people, we see the threat scenario in Europe and globally unchanged and highest since the end of the Cold War.”

Renk’s share price, which has gained around 194% year-to-date, was last seen trading 4.8% lower.

“Downward movements of the share prices are strongly driven by market sentiment rather than by clear impacts on the business outlook of Renk and other defense peers,” the company’s spokesperson added on Tuesday morning.

“European NATO members have committed to the 3.5% [spending] target until 2035, leading to a structural long-term growth environment in military budgets,” they said.

Europe’s defense sector has seen a meteoric rise this year, amid the Ukraine war and commitments from regional governments and the NATO military alliance to ramp up defense spending.

The pledges are widely expected to boost European firms’ bottom lines, with regionally headquartered companies already reporting record order backlogs and huge upswings in income.

Since the start of the year, the Stoxx Europe Aerospace and Defense index has surged more than 50%, with some regional defense players more than doubling in value.

Hensoldt and Renk’s view that Russia will continue to pose a threat to the continent is shared by regional officials.

“We are Russia’s next target, and we are already in harm’s way,” NATO Chief Mark Rutte said in a speech last week, while Blaise Metreweli – the head of the U.K.’s Secret Intelligence Service – warned in a speech on Monday that the region is facing “the menace of an aggressive, expansionist and revisionist Russia.”

Christopher Granville, managing director of TS Lombard, told CNBC’s “Europe Early Edition” on Tuesday that, while the “end game phase” of the war appears to be underway, money markets may be mispricing this.

“The markets are pricing that in the form of a peace dividend,” he added. “That can be seen in the retracement of the share prices of European defense companies, which have handily outperformed for the last two to three years and have pulled back – in our view, that looks like a buying opportunity, because there will be no peace dividend.”

Granville argued that this is because Russia’s relationship with Europe has shifted.

“The outcome of the war will be that Russian military power has secured an unreversed territorial change in Europe, and that will be a huge incentive to improve European defense industrial capacity, and continue arms procurement,” he added.

He added that a “non-peace dividend” would be reflected in lower risk premiums, because, even with the war over, “you still get the spending on defense industrial capacity.”

Michael Field, chief equity strategist at Morningstar, called the market reaction to a potential peace deal “overdone.”

“The Ukraine war has been a significant driver of the European defense sector, but what the market is overlooking now is that the Ukraine war set about a series of structural drivers to the sector, drivers that remain in place even if a peace agreement is reached,” he told CNBC.

“An increase in NATO spending targets has been agreed by participating members and will not be unwound. Similarly the restocking story remains intact. It will likely take nations like Germany a decade at least to restock weaponry supplied to Ukraine. Both of these conditions will be highly supportive of the European defense sector for the medium term, into the longer term, supporting share price valuations,” he added.

Claire Titmarsh, a defense equity analyst at U.K. wealth management firm Rathbones, told CNBC: “It seems unlikely the risk of aggression will be fully eliminated.”

“What’s more is that predicted increases in European defense spending are not solely driven by the Ukraine war. Deep-rooted structural factors persist: long-standing underinvestment, the ongoing strategic challenge from Russia – even after a Ukraine settlement – and the imperative for European strategic autonomy amid signals that the U.S. will reduce its role in underwriting European defense,” she said by email on Tuesday.

She also questioned how stable any peace settlement would actually be.

“Whether Russia will honor any peace agreement remains highly uncertain,” Titmarsh added. “History suggests caution and President Putin’s behavior is notoriously unpredictable.”

— CNBC’s Justin Papp and Holly Ellyatt contributed to this article.