Geopolitics Needs Policy to Move Risk: 3-Minute MLIV

Key Concepts

• Geopolitical Risk: The impact of political instability and events on financial markets, often characterized by low probability, high impact scenarios.
• Policy Changes (Trump Administration): Unexpected shifts in government policy and their effect on market volatility.
• Commodity Hedging: Utilizing commodities (oil, gold) as a portfolio hedge against geopolitical and inflationary pressures.
• AI & Inflation: The dual impact of Artificial Intelligence – potential deflationary cost reductions versus inflationary demand increases and supply chain pressures.
• Tech Trade & Returns on Capital: The ongoing investment in technology and its correlation with equity performance and overall economic growth.
• Volatility Hedging: Strategies to mitigate risk in a market experiencing policy-driven uncertainty.

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Market Sentiment & Geopolitical Factors

The current market environment is characterized by a loss of risk appetite following a strong start to the year. Multiple crosscurrents are contributing to this shift, with particular attention focused on upcoming US economic data releases. While geopolitical headlines are present, Montgomery Koning argues they typically elicit an initial risk-off reaction, followed by a return to fundamental trading once the worst-case scenarios don’t materialize. He emphasizes the difficulty in pricing geopolitical risks, specifically citing low-probability, high-impact events like nuclear war, which render asset valuations essentially meaningless. He suggests focusing on actual policy changes stemming from geopolitical events rather than the headlines themselves.

Policy Impact & Volatility

A significant driver of recent market fluctuations is the implementation of policy changes under the Trump administration. The market has repeatedly been “wrong-footed” by these changes, raising the question of how to price policy-driven volatility. Koning suggests that, given the currently relatively low volatility levels, exploring hedging strategies is prudent, particularly as the specific nature of future policies remains uncertain. He notes that policy impacts often manifest through commodity prices, referencing historical examples like the Red Sea disruptions and the Russian invasion of Ukraine, which led to increased oil and energy prices and negatively impacted both bond and equity markets.

Commodities as a Hedge

Considering the potential for geopolitical and inflationary pressures, Koning advocates for incorporating commodities into a portfolio as a hedge. Specifically, he highlights gold as a real asset that can provide protection. This is based on the understanding that geopolitical events frequently impact commodity prices, and commodities can serve as a buffer against inflation driven by energy, chip, and datacenter input costs, as well as supply chain disruptions.

AI, Inflation & the Tech Trade

The discussion then turns to the impact of Artificial Intelligence (AI) on inflation. Koning posits that while AI presents both inflationary and deflationary forces, the inflationary impact currently dominates. He draws parallels to previous technological advancements, noting that decreasing US costs associated with AI adoption will drive widespread use, increased productivity, higher growth, and improved returns on capital. This environment, characterized by higher demand, is inherently inflationary and supports stronger equity returns. He specifically states, “what I think dominates is the inflationary impact.”

US Equity Outperformance

Koning further argues that the US is uniquely positioned to benefit from the AI revolution, having led previous technological advancements. This leadership suggests that US equities are likely to outperform other markets during this period. He explicitly states he is “not necessarily worried about the end of the tech trade” due to these factors. He explains that the lowering of US costs through AI allows for broader adoption, boosting productivity and returns on capital, ultimately creating a favorable environment for equity growth.

Logical Connections

The conversation flows logically from an overview of current market sentiment to a detailed analysis of the factors influencing it. The discussion moves from broad geopolitical concerns to the more concrete impact of policy changes, then delves into the specific economic implications of AI. The recommendation to include commodities as a hedge directly stems from the identified risks associated with geopolitical events and inflation.

Notable Quotes

• “Geopolitics is very, very hard to price. It's a kind of low probability, high impact event.” – Montgomery Koning
• “What I think dominates is the inflationary impact [of AI].” – Montgomery Koning
• “I’m not necessarily worried about the end of the tech trade.” – Montgomery Koning