So Trump's making noises about Putin going "absolutely CRAZY" and firing missiles "for no reason whatsoever." Markets yawned through the statement yesterday, but maybe they shouldn't have.
I've long held that the market has a peculiar relationship with geopolitical risk – it tends to ignore it entirely until suddenly it doesn't. This creates what I call the "geopolitical discount cliff," where assets are priced as if significant conflicts will remain neatly contained until the very moment containment fails. Then everyone acts shocked.
Look at how markets have priced the Russia-Ukraine conflict. After initial volatility in early 2022, investors essentially decided "this is terrible but won't affect my tech stocks or bond portfolio." That assumption has largely held – but assumptions have a funny way of working until they don't.
Trump's comments feel different from his usual stream-of-consciousness pronouncements. There's something more calculated here. He's simultaneously criticizing Putin (unusual for him), blaming Zelenskyy, and setting himself up as the counterfactual savior who would have prevented it all. This triangulation suggests positioning for something beyond just campaign talking points.
The timing is interesting too. Why this pivot on Putin now? The former president isn't exactly known for random acts of geopolitical concern. Markets should at least consider the possibility that he's receiving intelligence briefings that suggest escalation risks are higher than publicly acknowledged.
If – and this remains a big if – we see further escalation toward a wider conflict involving NATO directly, markets are not remotely positioned for it. We'd likely see:
- A massive treasury rally as yields plummet in a flight-to-safety reaction that would make the COVID crash look orderly by comparison
- Equity markets dropping 15-25% in short order, led by high-beta tech and consumer discretionary names
- Defense contractors soaring (Raytheon, Lockheed, General Dynamics would be the trade of the decade)
- Oil potentially spiking 50%+ if Russian supply is fully compromised
- Gold breaking $2,500 as the ultimate fear trade
The problem with geopolitical risk is that it follows a barbell distribution of outcomes. For years, nothing happens, convincing investors that nothing will happen, until suddenly everything happens at once. It's the financial equivalent of "how did you go bankrupt? Gradually, then suddenly."
I'm not predicting World War III tomorrow morning. But markets are clearly mispricing tail risk. The VIX below 15 and credit spreads near historic tights suggest a complacency that feels increasingly disconnected from the rhetoric of major world leaders.
A friend who runs a macro fund told me recently, "The market doesn't want to believe in the possibility of serious conflict because no one trading today has managed money during a major war." That's worth considering. Our risk models are built on recent history – which has been remarkably peaceful by historical standards.
The irony here is that markets have been obsessively focused on Fed policy minutiae while potentially missing the largest risk factor on the horizon. We debate whether rates will be cut 25 or 50 basis points while ignoring that a significant geopolitical escalation would force emergency cuts regardless of inflation data.
Institutional investors might want to consider cheap tail hedges – deep out-of-the-money puts, long-dated VIX calls, or even small allocations to gold and defense stocks as a portfolio insurance policy. The cost of being wrong is minimal; the cost of being unhedged if things escalate could be catastrophic.
Of course, this could all blow over, and Trump's comments might just be another addition to the noise machine. But when geopolitical risks are so asymmetric, a small insurance policy seems prudent.
After all, markets aren't pricing in conflict escalation – which means if it happens, the repricing will be swift and brutal. And as always in markets, it's not the risks everyone sees that cause the real damage, but the ones hiding in plain sight that we collectively choose to ignore.
