Are Mega-Forces Making for a Riskier World?

The effects of mega-forces are turning up in recent policy and geopolitical developments.

We expect a gathering of mega-forces to dominate the investment landscape for the next decade or longer, with major implications for the macro regime and portfolio design. A recent surge in US policy changes has greatly accelerated the manifestations of these mega-forces—to the point where they might have a significant near-term impact and, in other cases, worsen the long-term outlook.

Here, we focus on accelerating deglobalization, debt sustainability and rising geopolitical risks—how they’re playing out in recent headlines and how they interrelate.

Tariffs, Trade Wars and Supply Chains

Tariffs were a cornerstone policy of Donald Trump’s presidential campaign, and we’ve already seen a flurry of executive actions and proposals. The continued back and forth between the US and other nations creates much uncertainty around the ultimate magnitude of the tariffs, but they’re likely to have both a short-term impact and potentially long-lasting economic implications.

Higher tariffs will likely accelerate deglobalization and the fragmenting of trade connections. This necessitates the need to rebuild, reconfigure and reshore supply chains—an effort requiring structurally higher infrastructure spending. As supply chains shift from “just in time” to “just in case,” businesses and industries must build in redundancies and carry higher inventories, increasing inefficiencies and costs—with investment in automation one avenue for combating the challenge.

Since the 1950s, a structural decline in tariff duties had been a key factor in the growing reliance on world trade, illustrated by ever-rising levels of global trade intensity (Display). A sharp decline in trade intensity from a renewed bout of tariffs would, in our view, be a significant drag on global economic growth. Higher trade barriers and more-fragmented supply networks resulting from raising the trade “drawbridge” also impair the ability of the world economy to absorb any price shocks. As a result, we expect not only higher structural inflation but higher inflation volatility.

Meanwhile, with geopolitical risk intensifying—particularly rising tensions between the US and China—countries are increasingly viewing supply-chain integrity and strong manufacturing bases as matters of national security. The coming years—and possibly decades—could see substantial growth in governments’ involvement in assessing these issues and managing the responses.

We saw a recent illustration of this development when the US imposed tariffs on steel and aluminum and initiated a probe on copper imports, addressing instances of trade reliance as threats to its security. National-security interests are also evident in the Trump administration’s desire to secure rare earth minerals at almost any cost and to boost oil production to strengthen the position of the US as the world’s largest oil producer.

High Debt Burdens Could Also Become National Security Issues

Public debt in G-7 nations has been rising steadily as a share of gross domestic product (GDP) since the mid-1970s, with the debt burden recently reaching the same level it was at the end of WWII (Display). The scale of that debt, combined with a turn in the long-term path of interest rates, will likely cause debt-service costs to require a growing share of government spending for decades. US debt-servicing costs, $882 billion in 2024, now exceed the country’s defense budget of $874 billion. Historian Niall Ferguson recently asserted that “Any great power that spends more on debt…than on defense will not stay great for very long,” referencing the Hapsburgs, ancien régime France, the Ottoman Empire and the British Empire.

Europe faces similar pressures from higher debt burdens, with a tangible connection to regional security. The region’s elevated debt levels and its aging population’s need for social spending imply that interest expense will exert long-term constraints on governments’ ability to boost defense spending. While Germany has just managed to implement fiscal change to exempt spending on defense and infrastructure from debt limits, the region still faces headwinds. Higher debt and interest burdens also rob governments of the fiscal headroom to respond with sizable stimulus to major geopolitical, health or other shocks. This echoes the challenges we saw during the COVID-19 pandemic and its aftermath, raising the probability of higher macroeconomic volatility.

Geopolitical Risk Is Rising…and Markets Are Bad at Pricing It

Assessing and responding to geopolitical risk is a challenging proposition on its own, but it is also vulnerable to investors’ recency biases. One notable bias is the assumed presence of the post-WWII US-led international order, and the defense guarantees that this umbrella provided. This order is now in doubt, exacerbating geopolitical risk.

The main mechanism for transmitting this geopolitical risk to equity markets is through the equity risk premium (ERP). However, based on the history of this measure, markets have generally been poor at anticipating geopolitical shocks (Display). The risk premium typically doesn’t rise in expectation of big shocks; instead, it has generally surged when a shock occurs.

As we see it, it’s impossible to quantify a level of risk premium that would reflect the changes we expect in the post-WWII geopolitical regime. However, this shift does suggest to us that there’s meaningful upside risk to the risk premium from its current level. Given the inability to specify such a risk premium, it doesn’t enter our forecast for long-term equity returns, but it should be an area of concern and vigilance for long-term asset allocators.

AI’s rapid advances in the past few years add a layer of uncertainty. As we have shown, AI complicates the geopolitical picture: there’s no established way to deter it, and it boosts the inherent risk that preempting it will escalate into conflict. AI’s emergence makes future conflicts less predictable—they’ll involve a growing number of strategies determined or influenced by nonhuman actors.

This is particularly true in the case of cybersecurity risks. Unlike other geopolitical conflicts, in cyberconflicts it is much less clear who your opponent is, what stage of conflict you are in and what the optimal response should be. A particularly damaging scenario would be an AI-powered adversarial attack used to exploit vulnerabilities in supply chains, which could trigger significant social and economic disruption. Meanwhile, AI’s ability to generate and spread misinformation and believable falsehoods could well undermine the functioning of democracies.

A Riskier World, but Not a Bearish Outlook for Risk Assets

There’s little question that we’re operating in a tougher environment than the one that prevailed during the past 15 years, with much more macroeconomic uncertainty and geopolitical instability. As a result, investors should expect greater volatility in their portfolios and the prospect of greater path risk, not least because most asset-class valuations are historically elevated.

However, most investors need to earn real returns in a world of rising structural-inflation risks, so we think equities should remain a core portfolio allocation. Near term, earnings growth should provide some support—although estimates are being revised in the wake of the announcement of widespread tariffs. Prior to the announcement, consensus expected a 12% increase globally for 2025, with robust profit margins. But low-single-digit earnings growth is now more likely, with the potential for that figure to fall if elevated tariffs or elevated levels of uncertainty persist. Longer term, our research indicates that if inflation doesn’t become unanchored above 4%, firms will generally be able to pass rising costs on to consumers, and overall market multiples don’t need to contract. We expect buybacks, currently at around 1.5% per year globally, to be another source of durable support for stocks.

This new investment regime also necessitates greater diversification of return streams when designing asset allocations, particularly higher exposure to real assets, which should help dampen the impact of inflation and geopolitical risks.