Geopolitical Risk is Evolving: What You Should Know

In the past, sudden shocks or the anticipation of geopolitical risk escalation such as armed conflicts have created short-term market volatility. Energy markets are particularly prone to these geopolitical shocks, particularly when there is potential for supply chain disruptions. Future disruptions to energy supply could drive prices higher in the short term, but the gains may not be sustainable without large-scale, extended interruptions in supply, because the global economy is in a state of excess supply of oil.

Historically there have been few geopolitical events that have caused prolonged market impacts. Generally, we observed prolonged negative market impacts occurred during economic recessions, which may have been exacerbated by geopolitical events. Our analysis of events dating back to 1970 indicates that geopolitical shocks have driven heightened short-term volatility but haven't typically had a long-lasting impact on equity markets, outside of recessions.

Today we may be entering a period where geopolitical pressures are causing a fracture in global interconnectedness. Changes in U.S. economic and geopolitical policy are motivating other countries to take steps to mitigate domestic impacts—by forging new trade alliances and increasing defense spending. In their formal speeches at the World Economic Forum in January, Canadian Prime Minister Mark Carney called this the "rupture in the world order" and German Chancellor Friedrich Merz said the "old world order is unraveling at a breathtaking pace."

Unlike the short-term market impacts of most geopolitical shocks, geopolitical fracturing could have more lasting implications. A move toward global trade protectionism could change investment risk profiles and result in companies building manufacturing capacity in higher-cost locations than in the past. Protectionism could also result in less cooperation across countries, leading to bottlenecks and resource hoarding in raw materials or other manufacturing inputs. The result: potentially higher inflation, more frequent supply shocks, and increased bouts of market volatility over the longer term.

Last year countries outside the U.S. stepped up the pace to diversify away from the U.S. by building trade alliances with each other. This trend seems to be continuing, evidenced by announcements already made in 2026.

The European Union (EU) and India resolved nearly two decades of deadlock, signing a historic free-trade agreement covering 2 billion people and a quarter of global gross domestic product (GDP), according to official government announcements. The EU also agreed to a free-trade deal with the South American trade bloc known as Mercosur after 30 years of negotiation. Other negotiations include Canada and South Korea signing an agreement to advance the Korean automotive footprint in Canada and cooperate on critical minerals and energy.

Countries may seek to strengthen economic ties with China to offset reduced dependence on the U.S. There has been movement on this front this year, as well. Canada and China entered a deal to cut tariffs in January. U.K. Prime Minister Keir Starmer visited China this year, the first official visit since 2018, suggesting a potential reset in economic relations between the two nations. South Korean President Lee Jae Myung met with Chinese President Xi Jinping in January to discuss a "full-scale restoration of Korea-China relations" according to South Korean newspaper Chosun, and German Chancellor Friedrich Merz is visiting China in February.

Other countries may still view China with some caution, as evidenced by continued tension in Australia despite its improved trade ties with China in recent years. As a result, a shift to a multipolar world seems to be underway, where multiple powers of varying strengths compete, including for access to critical resources.

The investing implications of higher geopolitical tensions and the decreasing support by the U.S. to underwrite military security for Europe resulted in NATO agreeing to more than double its defense spending as a percentage of GDP in June 2025 from a prior target of 2% to 5% by 2035. Europe is likely to prioritize European defense contractors. Increased defense spending is happening globally; contractors in Japan and Korea also experiencing expanded opportunities from their governments. The risk is that not all countries have fiscal room to increase defense spending and expectations about the potential opportunities may be elevated.

Historically, geopolitical shocks have had only temporary impacts on financial markets. However, geopolitical pressure is causing a fracture in global interconnectedness and could have more lasting implications. Indeed, we've seen a rise in these pressures for several years now. Investors may need to think about adjusting the positioning of their portfolios to account for the evolution in geopolitical risk.

Heather O'Leary, Senior Manager, Equity Research and Strategy, contributed to this report.