Morgan Stanley resets bets on defense stocks amid war

The sudden escalation in the U.S.-Iran war has rattled global markets. Oil prices are climbing, volatility is back and strong, and investors are once again asking one familiar question: Where can money hide during geopolitical uncertainty?According to analysts at Morgan Stanley, the answer may lie in two sectors. That is defense and energy. Why? Because both have historically gained attention during global conflicts.In early March 2026, the Wall Street bank revised its investment outlook amid rising tensions in the Middle East. The firm highlighted defense companies as a high-conviction opportunity, while maintaining a broadly bullish stance on U.S. equities.But why are defense stocks suddenly back in the spotlight? Which companies could benefit the most?Morgan Stanley says defense stocks could benefit from geopolitical tensionsMorgan Stanley analysts argue that escalating global conflicts often push investors toward industries tied to national security and energy supply.That trend appears to be unfolding again.The U.S.–Iran confrontation has sparked a classic “risk-off” reaction in financial markets. Oil prices are surging every new morning. With that, investors have rotated into safer sectors and companies tied to military technology.One early standout is Palantir (PLTR). PLTR has so far recorded a 17% gain over the past month amid geopolitical developments. The company’s deep ties with the U.S. military and intelligence agencies make it a key player in modern defense technology.More Palantir Palantir CEO delivers curt 8-word message to investorsPalantir drops immigration enforcement bombshellPopular analyst reveals 9 ‘buy the dip’ tech stocksMorgan Stanley analysts say the correlation between rising energy prices and defense stocks has strengthened during the latest geopolitical shock.Meanwhile, sectors such as autos and banks, traditionally tied to economic growth, are facing more caution from investors.So where exactly are analysts placing their bets?Morgan Stanley recently re-evaluated major defense contractors and re-stacked its industry ratings, highlighting companies with strong exposure to next-generation military technologies. Shutterstock Among its top picks is Northrop Grumman, which the firm considers a standout due to its advanced defense portfolio and consistent performance.Rising U.S. defense spending could also unlock major contract opportunitiesBehind Morgan Stanley’s optimism lies a powerful macro trend: rising global defense budgets.The White House has proposed $1.01 trillion in defense spending for 2026, one of the largest military budgets in U.S. history.Roughly $150 billion has already been appropriated through the One Big Beautiful Bill Act, funding initiatives like the Golden Dome anti-missile program and modernization of the U.S. nuclear arsenal.Still, much of the spending has not yet translated into contracts.That gap could create opportunities for defense contractors as funding moves through the appropriations process.Key programs expected to receive funding:$3.9 billion for hypersonic weapons$3.5 billion for next-generation F-47 fighter jets$2.5 billion for missile and munitions production$15.1 billion for cybersecurity initiativesA 30% increase in Space Force funding to $40 billionStill, that’s not enough yet. Towards the end of 2025, the Pentagon also asked defense companies whether they could quickly manufacture 300,000 drones. That’s huge. And that's interesting too. Why? This signals massive potential demand in that sector.Several companies are to benefit if these programs move forward.Lockheed Martin (LMT)Northrop Grumman (NOC)RTX Corporation (RTX)General Dynamics (GD)Despite that clarity, investors remain cautious. Why? The lengthy and sometimes opaque federal budgeting process has historically made it difficult to predict which companies will ultimately win the biggest contracts.The Middle East conflict is also shaking global energy marketsThe recent U.S strikes on Iran triggered spikes in WTI crude, Brent crude, and natural gas prices, with tensions disrupting shipping through the Strait of Hormuz.Related: 156-year-old energy giant to pay $17 billion in dividends as oil spikes to $110Economists at Morgan Stanley describe the disruption as more of a logistics shock than a production shock, noting that no oil supply has been lost so far.Still, higher oil prices can ripple through the economy. A moderate increase tends to push headline inflation higher temporarily, though the Federal Reserve often looks past such short-term pressure.A much larger oil spike could tell a different story.Morgan Stanley expects an upward revision to the 4Q GDPRising energy costs could slow economic activity, weaken business confidence, and delay hiring or investment plans. That uncertainty is precisely why defense stocks often gain attention during geopolitical crises.Yet Morgan Stanley remains surprisingly optimistic. According to the company statement, they expect an upward revision to 4Q GDP to a 1.5% quarter-over-quarter annualized rate.The firm also argues that history shows geopolitical shocks rarely trigger long-lasting bear markets. Especially if inflation pressures remain contained. In other words, volatility may rise, but the broader bull market could survive.Related: Oil spike sends powerful message for everyone