September was expected to be bumpy for stock markets. There was talk of a crash, as artificial intelligence mania drives Wall Street valuations to the stars, and US tariffs threaten to trigger a recession.
Instead, the S&P 500 enjoyed its best September in a decade, climbing 4.25 per cent to close at 6,688.46 points, while the tech-focused Nasdaq jumped 6.49 per cent. Japan’s Nikkei 225 ended the month up 5.65 per cent, while bourses in London and Europe ended positively, too.
Yet, investors remain uneasy, as they often do at this time of the year. October hosted both the Wall Street crash in 1929 and the Black Monday sell-off in 1987. Could the 16-month bull market finally come to an end this month?
There are reasons to be nervous. The Shiller P/E ratio, which values indices by comparing stock prices against average 10-year earnings, has just spiked to 40.11, far above its mean of 17.28. A higher figure suggests the index is expensive, and future returns potentially lower. The S&P 500 has only breached the 30 mark twice in history.
This time, bubble fears centre on AI, with Nvidia’s $100 billion investment in OpenAI seen by many as a symbol of today’s excess, a clear echo of AOL’s ill-fated $182 billion merger with Time Warner, announced in January 2000, weeks before the dot-com crash.
Tariffs continue to hit global trade. Western governments are struggling to control spending and rein in deficits. Adding to the uncertainty, Washington has just shut down, risking hundreds of thousands of jobs and billions of dollars in lost output.
Kyle Rodda, senior analyst at Capital.com, says September’s rally was fuelled by hopes of “aggressive” rate cuts from the US Federal Reserve.
“But with inflation remaining above its 2 per cent target, the risk of a nasty surprise and a deeper pullback is high,” he adds.
Markets are struggling to find stability despite their strong September, according to Vijay Valecha, chief investment officer at Century Financial in Dubai.
“US tech valuations look frothy, gold appears overbought and government bonds face currency threats.”
Jacob Falkencrone, global head of investment strategy at Saxo Bank, rejects fears of an AI bubble to match the dot-com meltdown, arguing that today’s tech leaders are highly profitable with strong cash flows.
Yet, he is concerned by elevated stock valuations and market concentration. “Ten companies account for around 40 per cent of the US market, which itself makes up 72 per cent of global stock markets. Investors think they’re diversified through exchange-traded funds and mutual funds but are effectively holding overlapping exposures.”
That creates fragility, Mr Falkencrone warns. “Market prices currently embed perfect performance expectations, so even small earnings setbacks could trigger sharp reactions.”
One sector is holding the line though. “Defence stocks are emerging as a rare pocket of resilience. With geopolitical tensions escalating from Ukraine to the Middle East, governments are doubling down on military spending and investors are taking notice,” Mr Valecha says.
The action is being driven by Europe’s “structural rearmament cycle”, he says. “Ageing arsenals, Nato’s move to lift defence spending to 5 per cent of gross domestic spending by 2035, and Germany’s decision to exempt defence outlays from debt limits are unlocking billions in future contracts.”
The impact on listed defence stocks has been dramatic. “In Germany, Rheinmetall has more than doubled year-to-date on Leopard tank and air defence orders, while Hensoldt has secured €1.4 billion ($1.6 billion) in contracts in just three months. Italian defence firm Leonardo has doubled on its exposure to the F-35 and Eurofighter Typhoon programmes,” Mr Valecha says.
He highlights a similar story in the US, where Lockheed Martin has won a $4.3 billion missile contract, while L3Harris secured $292 million to supply Javelin rocket motors. Airbus reported a record €629 billion defence and space order backlog at the end of 2024, up 13.5 per cent from €554 billion on year earlier.
“These are long-term, government-backed contracts that generate non-cyclical revenues largely insulated from downturns. Valuations are richer after a stellar run, but in a fragmented world, the sector offers not just growth, but strategic certainty,” Mr Valecha says.
Mr Falkencrone agrees that defence stocks are flying and could get a further lift from their close ties to the rapidly growing space industry, driven by private sector innovation in satellite communications, commercial exploration and space tourism.
“These developments create strong synergies with defence, automation and AI technologies, supporting a compelling investment theme amid today’s uncertainty,” he adds.
Yet, Mr Falkencrone warns valuations are starting to look stretched. “After such a powerful rally, investors need to be selective.”
While the defence stock rally has been powerful, Jason Hollands, managing director of fund platform Bestinvest by Evelyn Partners, worries about prices. “Rheinmetall trades on a hefty 39 times forecast earnings. Even BAE Systems, at 21.5 times, is hardly a bargain. From here, earnings growth will need to justify valuations.”
Tony Hallside, chief executive of STP Partners, notes that global aerospace and defence stocks are up around 45 per cent year-to-date, but are starting to look expensive. “The theme is real, but it isn’t a free pass.”
chief investment officer, Century Financial
Other safe havens remain relevant, he argues. Gold is still breaking records, although “prone to sharp pullbacks after such a parabolic move”.
US Treasuries still yield more than 4 per cent, a real return after inflation. “Defence isn’t the only refuge, but it does combine contracted cash flows, budget support and geopolitical relevance,” Mr Hallside says.
Edge of a new bull market
Not everyone believes markets are staring into the abyss. Mr Hollands suggests we could even be on the edge of a new bull market as AI delivers.
For those seeking to diversify from tech, he names health care and infrastructure as particularly resilient, despite US President Donald Trump announcing 100 per cent tariffs on branded and patented imports from October 1.
“Health care is relatively insensitive to the economic cycle. People don’t stop taking their medication in a downturn,” Mr Hollands says.
He also highlights infrastructure, which he says is supported by long-term contracts, many inflation-linked. “That makes it a defensive asset class for those concerned about a potential downturn.”
Gold may also continue to shine, Mr Hollands says. “Despite its strong run, it’s under-owned by private investors. Central banks currently hold 15 per cent to 20 per cent of their reserves in gold, but historically it's been up to 50 per cent, so there's scope for more buying, especially from Brics nations seeking to diversify away from the dollar.”
Digital asset platforms such as Tether are also exploring gold investments, potentially adding another source of demand.
Despite their bulging order books, defence stocks carry risks, too. They may not be the only safe haven left, but in a world of fragile markets and rising tensions, they have plenty of firepower. It may be a sector to buy on a dip. If we get one.
