Rallies built on hope – how markets are pricing optimism while risks persist

Patrick Farrell, chief investment officer at Charles Stanley, part of Raymond James Wealth Management, highlights the risk that markets are becoming too quick to look past geopolitical and inflation pressures despite a more fragile global backdrop.

Financial markets have had a remarkable ability to look through bad news recently. Too quickly, some might argue. Recent equity rallies suggest investors are willing to latch onto any positive signal, even as the reality on the ground remains stubbornly uncertain. That willingness to believe is understandable, but it risks glossing over a more uncomfortable truth. The world is entering a period where geopolitical volatility, higher inflation and tighter financial conditions are not temporary disruptions, but structural features.

US equities, in particular, appear to be trading as though the United States sits at a safe distance from global shocks. While it may be less directly exposed to certain conflicts, it is far from insulated. Energy prices tell that story clearly. Rising fuel costs feed quickly into consumer spending, corporate margins and growth expectations. They act as a tax on the economy, regardless of where a conflict is physically located. Optimism that ignores those mechanisms could be built on shaky ground.

When uncertainty becomes the backdrop

This disconnect matters because markets are simultaneously pricing in an unusually strong earnings outlook, driven by the continuation of powerful technology gains and AI demand. Expectations remain elevated at a time when uncertainty spans geopolitics, supply chains, inflation and monetary policy that have massive implications for most other sectors. That combination leaves little margin for error. The key question for investors is not whether uncertainty exists – it clearly does – but whether current valuations adequately reflect it.

Geopolitical risk, in particular, is no longer episodic. It is not something that spikes briefly and then fades away. Instead, it has become embedded in the global system, shaping energy supply, trade flows and political alignment. Markets quickly revert to optimism and the FOMO trade (fear of missing out) and gradually discount the increasing probabilities and persistence of other economic shocks. They tend to price outcomes, often assuming eventual resolution. When resolution takes longer than expected, volatility resurfaces.

Corporate adaptability has limits

One argument frequently put forward in defence of higher valuations is corporate adaptability. Large, globally diversified companies have proved adept at navigating complex environments. Many have adjusted supply chains, diversified revenue streams and engaged more actively with policymakers.

But adaptability is not immunity. Even the best-run companies cannot fully offset higher input costs, tighter financial conditions or slowing demand. Elevated earnings expectations still require a supportive macro backdrop, and that backdrop is becoming more challenging.

The cost of money is the real test

The more immediate pressure point for markets may not be geopolitics themselves, but the cost of money. Inflation has forced central banks to pause their easing cycles or even consider tightening. This matters because many of the strongest bull-market narratives of the past decade were built on the assumption of cheap and abundant capital.

As interest rates reset at higher levels, highly leveraged businesses and long-duration growth themes face greater scrutiny. The risk is less about sudden collapse than a gradual reassessment of valuations that once looked unassailable.

Regional divergence is also becoming clearer. The US has benefited from fiscal support and resilient consumption, while Europe and the UK have faced slower growth just as monetary conditions tighten. Higher energy prices act as an additional burden, squeezing consumers and reducing policymakers’ room to manoeuvre.

Building portfolios for resilience

All of this argues for humility over precision. Attempting to trade every geopolitical twist and turn is a costly exercise in volatile markets. There remains a strong case for diversified portfolios built around core asset classes, but they need reinforcement rather than reinvention.

The traditional 60/40 framework is often declared obsolete, yet its underlying logic still holds. Growth assets provide returns; defensive assets provide resilience. The difficulty today is that some traditional stabilisers have behaved less predictably and even become more correlated under inflation scare scenarios. Bonds have been volatile, diluting their protective characteristics. Gold has at times moved in step with equities.

That does not mean stabilisation is impossible, only that it requires more thought. Select exposure to commodities, particularly direct exposure rather than equity proxies, can help mitigate short-term geopolitical shocks, especially those tied to energy. We also give careful consideration to alternative investment strategies, for example absolute return. The goal is balance, not bold bets.

Realism, not pessimism

Markets may well continue to rally. Hope is a powerful force, particularly when investors believe the conflict could be resolved at any moment. But investors should be careful not to mistake resilience for certainty.

In a world where risk is persistent rather than fleeting, the premium belongs not to bold prediction, but to disciplined portfolio construction and realistic expectations. Today’s environment does not call for pessimism. It calls for realism.