Are markets mispricing geopolitical risk?

With crises in Venezuela and Iran continuing to unfold, are markets weighing geopolitical risks appropriately?

Market recap

• After slipping early on following news the Fed and Chair Powell were under investigation from the DoJ, major U.S. equities see-sawed to post modest declines on the week.
• While the major U.S. equities were in the red, the TSX posted a 1.3% gain. Only the Nikkei (+3.8%) outperformed as a snap election looks imminent in that country.
• Energy, materials and industrials drove the gains in the TSX, while consumer staples, discretionary, and tech underperformed. In contrast, consumer staples led the pack for the S&P 500, followed by industrials and energy, although they weren’t enough to offset big losses driven by financials and banks (see above credit card cap).

Geopolitics

After weeks of pointed rhetoric, the Trump administration now appears to be moderating its comments regarding Iran. But given the ongoing Greenland-related tensions and the recent U.S. military action in Venezuela, are markets weighing geopolitical risks appropriately? At this stage, it does not appear that markets are pricing in the chance of more geopolitical risks. However, these risks tend to be more short-term in nature, so not pricing them in does have a certain logic. That said, there are some pockets of the markets where we think geopolitical risks should be taken more seriously—for example, oil and supply chains. In general, we expect continuing volatility to create some trading opportunities for nimble investors, as well as hedging opportunities for those seeking portfolio protection. Entering 2026, geopolitics was one of the major risks we identified. That’s why we’ve ensured that we have appropriate hedges in our portfolios, including gold for uncertainty and targeted options for specific events—for instance, the possibility of a spike in oil prices. In the past, those hedges have played out very well for us.

Bottom line: While markets may be correct in not pricing in geopolitical risks too broadly, we do think that investors should monitor how the risks may impact specific areas of the market, like oil.

U.S. banks

U.S. banks have begun to report their Q4 earnings, and so far, the initial reactions haven’t been positive. Some of them have seen some reversal, but not fully. Our view is that it’s important to see the full picture before coming to any broad conclusions about the state of the American economy. Companies like JP Morgan tend to have a good pulse on the broader economic situation. But it’s also important to hear from transaction-based Financials like Visa and Mastercard, as they provide a snapshot of the consumer spending environment. Results from regional banks can also provide a window into whether trends are broad-based or not. So far, the announcements haven’t included any major surprises—the consumer still appears to be slowing down a bit, but isn’t under massive pressure. Crucially, there is also no indication that significant job losses are on the horizon, which would likely bleed over into consumer spending. It is also worth noting that some of the market’s negative reaction can be attributed to disappointing trading revenues.

Bottom line: We’d like to see more earnings announcements before drawing conclusions about the state of U.S. economy, but so far, there have been no major red flags.

Small caps

With the small-cap Russell 2000 Index on a record run, is it time to consider a rotation to small caps (meaning companies with a market capitalization of less that $2 billion USD)? Though it was not one of our five investment themes for the year, our house view does have a slight tilt to small caps. There are a few reasons for optimism: the Big Beautiful Bill is likely to provide a tailwind for businesses, while interest rate cuts are likely to be disproportionately beneficial to smaller companies. There is also the potential for the U.S. economy to reaccelerate, in our view. Toward the end of 2025, hirings began to drop off. But in the early part of this year, they appear to have picked back up. It is still too early to know whether this will turn into a real trend, but as a single data point, it is an encouraging sign. Overall, we expect small caps to do well. You still want to own large-cap names, but in areas like Technology and artificial intelligence (A.I.), we think it’s worth considering moving down a spectrum to mid- and small-cap companies with more reasonable valuations.

Bottom line: We think a small tilt toward small caps makes sense given the potential for a positive U.S. economic surprise.

Positioning

For more insights on market risks and opportunities, including a video replay of my recent BMO GAM 2026 market outlook call, explore our 2026 Investment Outlook Centre .

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Originally Posted January 19, 2026 – Are markets mispricing geopolitical risk?

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