In brief
- Media focus on geopolitical risk may feel extreme but the geopolitical risk index (GPR)1 is only slightly above its long-term baseline.
- Still, political polarization is elevated, potentially frustrating consensus building and risking events escalating quickly.
- Geopolitical tension does not always overlap with market stress, but it can affect economies either by damaging confidence, and demand, or by disrupting supply chains.
- We favor bonds to protect portfolios from growth shocks and real assets to protect from inflationary risks. We note that a balanced portfolio is favorable to hiding in cash even during periods of heightened tension.
In five short days, we’ve witnessed an Oval Office encounter with more theater than anything Hollywood could dream up, a show of European unity that transcended post-Brexit mistrust, and a “tariff Tuesday” where Canada, China and Mexico found themselves on the sharp end of newfound U.S. enthusiasm for tariffs. Little wonder investors are asking us about geopolitical risk. While geopolitical tension surely drives headlines, it doesn’t necessarily drive markets – separating media hyperbole from market impact is crucial.
A cool-headed analysis of geopolitical risk should ask three questions:
- Are risks elevated compared to history?
- Are those risks driving markets today?
- How are investors responding to those risks?
In our view, geopolitical risk is slightly elevated but far from extreme. Nevertheless, political polarization has intensified and creates a more febrile environment. Investors are paying to protect portfolios, but equally they fear missing out on the upside should the narrative shift from tariffs to tax cuts or should a palatable path to peace emerge for Ukraine.
The Geopolitical Risk Index (GPR)1 highlights two important patterns. First, geopolitical risk is noisy and modest spikes in the index are common. Second, major spikes in tension associate primarily with outbreaks of war. The Russian invasion of Ukraine in 2022, and Chinese military maneuvers around Taiwan in 2023 caused the most recent spikes, but today the index is only slightly above its long run baseline.
We can look at geopolitical risk differently –questioning instead the potential for events to spiral out of control. The populism index2 shows that as of 2023 more than a quarter of voters were selecting extreme parties. If we consider the various European election results from 2024 and the German election in February 2025, that share approaches 30%. The increasing presence of radical parties can frustrate the process of consensus building and may create an environment where issues escalate more rapidly.
A more challenging political backdrop could be a reason for caution even if the geopolitical risk index is subdued. But the VIX index that is a proxy for market tension is poorly correlated to the geopolitical risk index. Sometimes events coincide, but some of the biggest routs in market history, such as the global financial crisis and the pandemic coincided with periods of geopolitical calm. It is the economic impact of geopolitical tension that can roil markets – not simply the rhetoric.
Even with the geopolitical risk index subdued, investors do appear to be responding to the challenging investing environment. As of the end of February, the relative price of protecting an equity portfolio with puts was in its 76th percentile3, implying that investors are paying up for “insurance.” Interestingly, however, the price of positioning for upside with calls and buying puts to protect the downside had reached its 67th percentile4. While investors want to hedge the downside, possibly triggered by geopolitical tension, they also fear missing out on the upside should events break positively.
Building portfolio resilience
For balanced portfolios and investors unable to turn to the options market, much can be done to build resilience. Geopolitical tension can spill into economies in two ways: denting confidence and demand, leading to a negative growth shock, or disrupting supply, in turn risking an inflation shock.
Recent price action in U.S. Treasuries shows that bonds continue to provide good returns as growth expectations moderate. In the event of a growth shock and a 200bps fall in rates, U.S., UK, and German government bonds could see returns of around 20% – potentially insulating equity portfolios from a drawdown associated with lower growth expectations. By contrast, during the inflation shock in 2022, real assets such as timber, infrastructure, and transportation delivered positive returns, even as the 60/40 stock/bond portfolio suffered its worst drawdown since 2008.
Simply put, we favor bonds for growth shocks, real assets for inflation shocks, and an active stance for the journey.
Finally, some investors feel that cash offers a good place to hide from geopolitical risks. To test this assumption, we looked at 12 major market shocks since 1990 to assess how cash returns compare to a 60/40 stock/bond returns. To ensure we set the bar high, we assumed that we invested the month before the negative shock took place. The result is stark. After one year, the 60/40 beats cash 75% of the time by an average of 7%. After three years, the 60/40 beats cash on all occasions by an average of 21% (Exhibit 1).
Geopolitical risk: Cash is NOT your friend
Exhibit 1: After Shocks, 60/40 beats cash 75% of the time by an average of 7% after 1 year, and 100% of the time by an average of 21% after 3 years
Source: Bloomberg, NBER, JP Morgan Asset Management, Caldara, Dario, and Matteo Iacoviello (2021), "Measuring Geopolitical Risk," working paper, Board of Governors of the Federal Reserve Board, November 2021“, Data as of September 2024; * 3y is period to 30 Sep 2024
Whatever your view of geopolitics today, data show that acute tension is lower than the media would have us believe. But even if we are in a more febrile environment, hiding in cash is not a winning strategy. Old wisdoms endure for a reason: it is time in the market, not timing the market, which wins in the long run.
Exhibit 2: Multi-Asset Solutions Asset Class Views
| Asset Class | Opportunity Set | UW | N | OW | Change | Conviction | Description | |
|---|---|---|---|---|---|---|---|---|
| Main asset classes | Equities | Equities — Overweight | Neutral | Low | Global growth close to trend supports ongoing earnings growth, valuations a headwind even with easing cycle in play | |||
| Duration | Duration — Neutral | Neutral | Not applicable | Rate cutting cycle limits upside for yields, but market may be pricing more rate cuts than realistic given solid pace of growth | ||||
| Credit | Credit — Overweight | Neutral | Low | Trend-like growth and attractive all-in yields supportive to credit despite tight levels of credit spreads | ||||
| Preference by asset class | Equities | U.S. | U.S. — Overweight | Neutral | Low | High quality and strong EPS but valuations, esp. in tech, are a headwind; concentration risks mitigated by cash flow generation | ||
| Europe | Europe — Underweight | Neutral | Moderate | Ongoing weakness in global goods cycle and evidence of inventory overhang in key industries hold back EU equities | ||||
| Japan | Japan — Overweight | Neutral | Low | Improving earnings yield and bottom up profitability point to upside, outflows suggest that overbought conditions from mid-year are behind us | ||||
| UK | UK — Overweight | ▲ | Low | Attractive valuations and higher free cash flows support UK equities, defensive nature of UK index adds diversification | ||||
| Australia | Australia — Underweight | Neutral | Moderate | ERRs continue to lag peers but valuations expensive; soft demand for base metals a headwind to mining sector | ||||
| Canada | Canada — Neutral | Neutral | Not applicable | Economy has shown some resilience in face of higher rates, but business outlook weak and valuations unappealing | ||||
| Hong Kong | Hong Kong — Overweight | Neutral | Low | Activity in China remains weak and is a headwind to earnings. but valuations and positioning are supportive and increased policy responses could provide a boost | ||||
| EM | EM — Neutral | ▲ | Not applicable | Earnings revisions very negative and flows not supportive in EM equities | ||||
| Fixed Income | U.S. treasuries | U.S. treasuries — Neutral | ▲ | Not applicable | Scope for fiscal stimulus and deregulation could improve U.S. growth and raise the equilibrium yield for USTs | |||
| German Bunds | German Bunds — Overweight | ▲ | Low | Potentially attractive as ECB looks set to cut rates at a decent clip, but with election risks in Feb 25 and yields already low may be at risk of volatility | ||||
| JGB | JGB — Underweight | Neutral | Low | Further BoJ hikes coming in 2025 maintain upside risks to JGB yields but at current levels demand is likely to remain reasonable | ||||
| UK Gilts | UK Gilts — Neutral | Neutral | Not applicable | Weak UK economy with scope for BoE to cut rates to offset worst impact of mortgage resets for UK consumers | ||||
| Australia bonds | Australia bonds — Neutral | ▼ | Not applicable | Least priced in for rate cuts of the major bond markets, also postive carry is an attractive feature | ||||
| Canada bonds | Canada bonds — Underweight | ▼ | Low | Has rallied a lot alongside the U.S. so spreads are tight and it is also the market with the most punitive carry dynamics | ||||
| BTPs | BTPs — Overweight | Neutral | Low | Lower ECB rates supportive to periphery bonds but near-term risks around election cycle in Europe could mean some volatility | ||||
| Corporate Inv. Grade | Corporate Inv. Grade — Neutral | ▼ | Not applicable | Robust corporate health and demand for quality carry; spreads tight, but carry advantage over sovereigns persists | ||||
| Corporate High Yield | Corporate High Yield — Overweight | Neutral | Low | Contained recession risks and improving quality in HY index supportive, spreads are tight but all-in yields are attractive | ||||
| EMD Sovereign | EMD Sovereign — Neutral | Neutral | Not applicable | Favor U.S. high yield to EMD sovereign given more fragile tail credits exposure in EMD compared to U.S. HY | ||||
| Currency | USD | USD — Overweight | Neutral | Moderate | Growth advantage of U.S. over RoW set to widen further, so even as Fed cutting cycle weighs on USD, growth differential is supportive | |||
| EUR | EUR — Underweight | Neutral | Low | EUR undermined by weakness of growth in Europe and likely need for the ECB to become more aggressive in cutting rates | ||||
| JPY | JPY — Neutral | ▼ | Not applicable | BoJ the only major central bank hiking rates, lends support to JPY as does solid domestic growth outlook | ||||
| CHF | CHF — Underweight | Neutral | Moderate | FX interventions have been reduced, and SNB on clear easing path, CHF could end up as the lowest yielder of the majors | ||||
The tick chart and views expressed in this note reflect the information and data available up to February 2025.