Megatrends: The latest AI and tech investment opportunities may be in global defense

In recent years, advancements in technology such as unmanned drones, robotics, autonomy and artificial intelligence (AI) has significantly reshaped the global landscape of defense. These innovations are not just modernizing military operations but are driving nations to rethink how they allocate and grow their defense budgets.

In 2023, for example, global military expenditures soared to $2.4 trillion, marking a 6.8% increase from the previous year – for the steepest annual growth since 2009. This surge is largely a response to deteriorating global peace and security, prompting countries like the U.S., China and Russia to ramp up defense spending.

Morgan Stanley’s Global Investment Office believes resurgent defense spending and tech innovation could help enhance productivity and stimulate growth across the broader economy, in addition to helping deter international conflicts. New technologies can provide investment opportunities in not only defense contractors but also ancillary beneficiaries including companies involved in the global supply chain, transportation, manufacturing, energy and cybersecurity.

Here’s what investors should know about this megatrend.

Despite the recent uptick in global military expenditures, U.S. spending on defense as a share of gross domestic product (GDP) and government outlays is at a historically low level that many experts consider insufficient to match the pace of adversaries and ensure deterrence. However, a shift is occurring. The U.S. Department of Defense – historically a cradle of innovation, with past contributions to personal computing and air travel, among other areas – is reigniting its investment in the defense industrial base.

This increased spend in the U.S. is part of a broader movement in which geopolitical conflicts are catalyzing reinvestment and modernization efforts across the globe.

• NATO members are increasingly aligning with the 2% GDP defense-spending target, with 23 out of 32 countries expected to have met or exceeded the benchmark by 2024 – a major increase from just three countries in 2014.
• Morgan Stanley Research projects that if all NATO countries meet their targets, an additional $54 billion could be unlocked globally.
• Moreover, scenarios reminiscent of the Cold War era could see global defense spending rise to 3.5%-4% of GDP, potentially unlocking hundreds of billions of dollars more in spending.

The U.S. is uniquely positioned to lead the charge in integrating cutting-edge technologies into defense. In 2023 alone, it led global private investment in AI, with $67 billion allocated – 8.7 times that of China, its closest competitor. This substantial investment is empowering the U.S. to use AI and other emerging technologies to maintain a competitive edge and bolster deterrence. Initiatives like the U.S. government’s Defense Innovation Unit and its Office of Strategic Capital are pivotal in this strategy, with the Pentagon actively investing in numerous venture deals with defense tech startups.

The ongoing transformation in the defense sector is a boon for traditional defense, energy and semiconductor companies, but it also challenges these companies to innovate and adapt, as new entrants in the defense market force established players to either innovate or acquire new technologies to stay competitive. The future landscape of defense is likely to be dominated by entities that can effectively integrate AI and other advanced technologies into their operations.

Despite potential long-term challenges like federal budget constraints and supply chain complexities, increases in defense spending should have positive ripple effects across the economy. Research shows that defense R&D not only enhances private sector productivity but also stimulates investment across industries and borders. Future defense strategies focusing on these high-return areas could lead to greater productivity and economic output, offsetting the potential increase in federal deficits.

The Global Investment Office sees investment opportunities among the large defense and aerospace contractors, but also in the “family tree” of ancillary sectors.

In particular, downstream beneficiaries of renewed innovation in the defense sector are expected within:

• Manufacturing, supply chains and logistics: The use of AI in defense for predictive maintenance, inventory management and automation could further enhance efficiency in civilian manufacturing and supply chains through smart factories, optimization and risk management.
• Transportation: Military advancements in autonomous vehicles, drones and robotics will likely influence the transportation sector, enhancing autonomous driving technology, traffic management and logistics automation.
• Cybersecurity: The defense sector’s focus on AI-driven threat detection and cyber defense will likely accelerate the use of AI in preserving critical infrastructure, financial systems and personal data, driving innovations in network security and encryption.
• Energy: AI systems in defense that optimize energy usage and battlefield operations can spill over to civilian energy management, leading to smarter grids, optimized resource allocation and better energy conservation techniques.

Article Footnotes

¹ The source of this article, The New Arms Race: How AI and Technology Are Redefining Global Defense, part of the Alphacurrents series, by Ellen Zentner, Morgan Stanley Wealth Management Global Investment Office, was originally published on 1/15/2025.

CRC# 4246515 2/2025