Why the Fear of Conflict Hurts More Than the Conflict Itself: 5 Surprising Insights into Geopolitical Risk

In 2017, a Gallup survey of more than 1,000 investors yielded a staggering consensus: 75% of respondents ranked geopolitical risk as their primary concern, placing it well ahead of both political and economic uncertainty. For decades, this “geopolitical risk” was the ghost in the machine a qualitative variable that moved markets but defied quantification.

Mark Carney, former Governor of the Bank of England, famously framed this as part of the “Uncertainty Trinity” in 2016, alongside economic and policy uncertainty. Yet, for the sophisticated investor, managing this trinity has traditionally been an exercise in intuition rather than data-driven strategy. That changed with the work of Federal Reserve economists Dario Caldara and Matteo Iacoviello. By synthesizing 120 years of archival data and modern text-search algorithms, we now have a quantitative framework to price tail risks that were once considered binary “black swans.”

1. We Can Finally Measure the “Unmeasurable”

Historically, assessing geopolitical risk relied on the sterilized clarity of hindsight or the subjective “expert opinion” of political scientists. This left investors operating in a vacuum of real-time sentiment. The Geopolitical Risk (GPR) Index solves this by shifting the focus from historical facts to perceived risk.

The methodology is high-signal: an automated tally of 11 leading international newspapers, including The New York Times, The Wall Street Journal, and the Financial Times. By tracking the frequency of articles discussing military tensions, nuclear threats, and terrorist escalations, the index creates a real-time proxy for the “global mood.” This is inherently more accurate for market participants because it captures the uncertainty of the moment as it is being priced into volatility regimes, rather than as a footnote in a history book.

“Geopolitics [is] the practice of states and organizations to control and compete for territory.” (Section 2.1, IFDP 1222)

2. The “Trumpets vs. Cannons” Paradox (Threats vs. Acts)

The most counter-intuitive finding in the Federal Reserve research is the distinction between a Geopolitical Threat (GPT) and a Geopolitical Act (GPA). The data suggests that the anticipation of conflict the “trumpets” is often more economically corrosive than the conflict itself the “cannons.”

When a threat surfaces, it creates a protracted period of ambiguity that paralyzes corporate investment and hiring. However, the actualization of that threat (e.g., the commencement of military operations) often functions as a “resolution of uncertainty.” While an act may be violent or destructive, it provides a “known evil” that allows markets to begin the process of stabilization. This data offers a rare quantitative blessing to the Rothschild dogma:

“Buy on the cannons, sell on the trumpets.” – Nathan Rothschild

• Threat Shock (GPT): Triggers a protracted rise in uncertainty, resulting in persistent declines in industrial production and employment.
• Act Shock (GPA): Results in smaller, short-lived effects, as the realization of the event resolves the preceding uncertainty.

3. The Stock Market’s Uneven Battlefield

A significant GPR shock calculated as a move of roughly 167 points based on historical peaks causes the S&P 500 to drop by a median of nearly 3% on impact. However, the macro-strategist must look beyond the headline index to see the industry-level divergence.

This is not a uniform retreat; it is a regime shift that creates winners and losers based on their exposure to the “Uncertainty Trinity.” To generate alpha during these shocks, one must distinguish between absolute returns and excess returns (performance above the S&P 500 benchmark).

Sector Performance during GPR Shocks:

• Negative Excess Returns: Steelworks, Mining, Aircraft, and Oil.
• Positive Excess Returns: Defense.

Interestingly, while the broader market reels, the defense sector acts as a natural hedge, capturing the increased fiscal focus on national security that typically follows a GPR spike.

4. The Oil Price Myth

Conventional wisdom dictates that geopolitical tension in the Middle East is a precursor to a parabolic move in oil prices. The Federal Reserve’s VAR (Vector Autoregressive) models challenge this narrative.

Unless a conflict directly destroys production capacity, the negative macroeconomic outlook and the subsequent “demand destruction” caused by global uncertainty usually outweigh the fear of a supply shock. According to the data, a standard GPR shock actually leads to a decline in real oil prices, bottoming out at 7% below the baseline approximately three months after the shock. For energy traders, the takeaway is clear: the market prices in the global demand slump faster than it prices in potential supply disruptions.

5. The “Flight to Safety” is a One-Way Street

Geopolitical risk acts as a massive redistributor of global capital, but it does not follow a symmetrical path. When GPR spikes, capital undergoes a “Flight to Safety,” exiting emerging markets with alarming speed.

A critical nuance for institutional investors is that the United States remains the primary safe haven even when the U.S. itself is a central party to the conflict. This is a counter-intuitive phenomenon where the dollar and U.S. Treasuries appreciate despite the domestic source of the risk.

Target Economy	Reaction to High GPR	Investment Implications
Emerging Economies	Massive capital outflows; reduced FDI.	EM yield spikes; currency depreciation.
Advanced Economies	Increased capital inflows (safe haven).	USD appreciation; lower Treasury yields.
U.S. (as Safe Haven)	Primary destination for capital.	Flight to quality regardless of U.S. involvement.

Note: While the VIX (economic risk) tends to repatriate capital across the board, GPR specifically shifts capital away from emerging markets toward the U.S. and other advanced economies.

Conclusion: The Century of Upward Drift

While the GPR Index reached its absolute zenith during the World Wars, the 120-year lookback reveals an unsettling trend: the index has been “drifting upward” since the turn of the 21st century. The post-9/11 era has established a higher baseline of “Threat” than the relatively stable period of the late 20th century.

As we navigate a hyper-connected media environment, we must ask: Are we in a permanent state of “Threat” that the global economy can never fully resolve? If the anticipation of conflict is indeed more damaging than the act, our modern penchant for 24-hour news cycles and digital escalation may be the greatest permanent headwind to global growth. For the sophisticated investor, the goal is no longer to avoid risk, but to price the “trumpets” before the “cannons” start to fire.