When US Stocks Are at Historic Highs, Is Trump More Likely to Start Wars? Goldman Warns Geopolitical Risks Are Underpriced

As stock markets repeatedly hit new highs and financial conditions remain loose, market sensitivity to geopolitical risks may be declining. In a report released Monday (17th), Rich Privorotsky, head of Goldman Sachs' trading division, warned that when the S&P 500 is at historic highs and financial conditions are extremely accommodative, the constraints markets impose on policymakers weaken—potentially lowering the political and economic cost of initiating conflict.

Privorotsky stated bluntly, "When markets are booming, starting wars actually becomes easier." He believes investors should pay particular attention to geopolitical tail risks, noting that the cost of hedging against extreme tail risks is currently at historic lows—making it an opportune time to build protective positions.

This warning contrasts sharply with recent market performance. Despite escalating tensions in the Middle East and attacks on ships, financial markets have reacted relatively mildly. The S&P 500 has rebounded near its highs, the VIX index remains around 14, and overall financial conditions are among the most accommodative in recent years.

The analysis suggests that market "desensitization" to geopolitical news is precisely the phenomenon Privorotsky finds concerning.

High Markets Reduce Policy Constraints, Geopolitical Risks May Be Underestimated

Privorotsky notes that as the U.S. approaches midterm elections, policymakers may adopt tough public stances while still considering economic rationality.

However, his core observation is that when stock markets perform strongly and financial conditions are loose, policymakers face less market pressure. Especially when the S&P 500 is at historic highs, market prosperity may reduce the economic cost of policy actions, making geopolitical conflict risks easier to overlook.

The analysis states that the Middle East situation remains highly uncertain, and oil inventories are at abnormally low levels. If oil prices remain in the $80–$90 per barrel range, the economy can withstand it, but further increases cannot be ignored.

Therefore, Privorotsky emphasizes that investors should not ignore geopolitical tail risks due to current market calm. Notably, the price of hedging tools for extreme tail risks is currently low, allowing investors to build protection at relatively limited cost.

Strategically, he maintains a risk-on stance, advocating holding nominal assets, shorting bonds, and buying relatively cheap volatility protection to increase convexity exposure in portfolios.

Deleveraging in July Concludes, Markets Approach Highs Again

From a positioning perspective, Privorotsky believes the deleveraging and position unwinding experienced by markets in July are largely complete. Total and net leverage have returned to relatively healthy levels, and overall leverage in the financial system has clearly declined.

Meanwhile, the S&P 500 has returned to high levels, the VIX hovers around 14, and financial conditions are near their most accommodative levels in recent years.

As this week approaches options expiration, markets remain near highs, with most covered call strike prices already breached. However, current market positioning remains below the historical average at similar index levels.

Privorotsky believes this positioning structure may pressure investors to chase further gains in September.

He also notes that the price of upside tail risk remains relatively cheap—European Stoxx index volatility is in single digits, and VIX remains around 14—making it worth considering maintaining upside option exposure in the short term.

AI Rally Still One-Sided, But Ultimately Returns to Free Cash Flow

Regarding the AI investment rally, Privorotsky believes the biggest beneficiaries may not be limited to specific companies but could be the broader stock market.

He points out that the AI industry continues to follow a clear technological and economic trajectory: the cost per unit of computing power continues to decline, while the real value created per dollar of computing power continues to rise. If this trend continues, it could eventually benefit most industries and companies, improving profitability across different business models.

However, he believes the true winners may not be the companies investing most in AI capital, but those that can access AI benefits at the lowest cost. Strong earnings during the recent reporting season have somewhat reduced market pessimism about AI's outlook.

On the future development of hyperscale cloud providers, Privorotsky refrains from joining the debate for now. He emphasizes he still follows the so-called "Cuba Gooding Jr. principle"—he won't buy unless free cash flow actually materializes.

Long-Term U.S. Treasuries Are the Market’s Biggest Problem, the Fed May Even Hike Again

In the current market environment, Privorotsky believes the real issue worth watching is interest rates, especially long-term rates.

He notes that pressure on U.S. long-term rates isn’t due to a single policy but relates to structural supply pressures.

With the U.S. fiscal deficit around 6%–7% of GDP, supply of U.S. Treasuries and investment-grade corporate bonds remains massive. Market crowding-out effects are emerging, term premiums are rising, and real yields remain at extremely high levels.

More notably, Privorotsky presents a relatively non-consensus view: if the Fed fails to achieve its inflation target over the long term, it may eventually face market skepticism about its policy credibility.

He points out that Beth M. Hammack, Lorie Logan, and Neel Kashkari voted to hike rates at the July policy meeting. If long-term rates continue to rise, the Fed may eventually be forced to take further action.

Privorotsky suggests the Fed might ultimately hike to restore policy credibility. He notes that while short-term rates are directly anchored by policy, long-term rates are not, and in this context, a flattening yield curve could be somewhat helpful.

Overall, Privorotsky maintains a slightly bullish strategy, favoring the S&P 500, gold, and shorting bonds, while recommending hedging extreme risks via low-cost VIX call options or spread strategies.

In sector allocation, he favors financials, semiconductor capex-related tech, industrials, and broad cyclicals. He is relatively bearish on bond-substitute assets lacking pricing power—such as consumer staples, telecom, and REITs—and prefers pairing long healthcare positions with related shorts.