What Happened
TREE NEWS reports: In a recent report, Goldman Sachs’ Delta-one trading desk chief, Rich Privorotsky, issued a stark warning: when the S&P 500 sits at record highs and financial conditions are extremely loose, the political cost of launching geopolitical conflicts actually diminishes. ‘When markets are booming, it becomes easier to start a war,’ he wrote. This insight, published on August 17, highlights a tail risk that investors may be underestimating amid current market complacency.
Market Impact Analysis
Stocks
Despite escalating Middle East tensions and attacks on shipping, the S&P 500 has returned to all-time highs, with the VIX hovering near 14. This ‘desensitization’ is precisely what worries Privorotsky. He maintains a risk-on stance, recommending holding equities, particularly financials, semiconductor capex-related tech, industrials, and cyclical sectors. However, he advises adding convexity through cheap upside options, as near-term upside tail risk remains inexpensive.
Bonds
Privorotsky identifies long-end U.S. rates as ‘the only real crux’ for markets. Structural supply pressures from large fiscal deficits (6-7% of GDP) are pushing term premiums higher and real yields to extreme levels. He suggests shorting bonds, as the curve could steepen or the Fed might be forced to hike again to restore credibility—a non-consensus view given some FOMC members already voted for hikes in July.
Commodities
Oil inventories are unusually low, and while $80-90 per barrel is tolerable, upside risks are significant if geopolitical tensions escalate. Gold is recommended as part of a nominal asset allocation, serving as a hedge against both inflation and geopolitical shocks.
Currencies
A potential Fed rate hike to defend credibility could strengthen the U.S. dollar in the medium term. However, in the near term, loose financial conditions and risk appetite may keep the dollar under pressure. Investors should watch for policy shifts that could alter this dynamic.
Crypto
While not directly addressed, heightened geopolitical risk often boosts demand for decentralized assets like Bitcoin as a hedge. However, in a risk-on environment with low volatility, crypto may remain correlated with equities, offering limited diversification.
Why It Matters for Investors
Privorotsky’s warning is a reminder that market calm can be deceptive. The very conditions that make investors complacent—record highs, low volatility, and loose financial conditions—also reduce the constraints on policymakers considering conflict. With tail-risk hedges at historic lows, he argues that now is a cost-effective time to buy protection. Investors should balance their risk appetite with prudent hedging, especially in a world where geopolitical shocks can emerge when least expected.
