Hedging against headline risks

With the U.S.-Iran conflict seemingly spilling over to other parts of the region, how should investors be pricing geopolitical risk?

Oil

Oil markets appear nervous once again, with the still-unresolved Iran conflict now spilling over into other parts of the region, including Yemen and Saudi Arabia. These risks are not likely to go away in the near term. The Trump administration adds a layer of uncertainty on its own, but in our view, the current conflict is not simply a function of Trump himself—U.S.-Iran tensions have been high for decades, and under another U.S. president, it is possible that a conflict could still have occurred, though perhaps not of the same magnitude. Given that reality, investors need to be aware that there needs to be a risk premium attached to anything that is related to that region, including oil. As we’ve already seen this year, markets tend to react strongly to the initial news of a conflict but absorb the situation quickly, essentially assuming that the situation will eventually return to the status quo. What we’ve seen in this situation is that oil prices—and, by extension, inflation—have stayed elevated longer than many were anticipating. That has kept the conversation around interest rate hikes at the forefront. President Trump has announced that he will not take any further military action on Iran before the U.S. midterm elections in November¹—but that does raise the question of what he might do after the elections, especially if it is not a good night for Trump’s Republican Party. The situation remains an important one to monitor, and while we are remaining neutral on Energy this month, our scores have gone up marginally in light of higher-for-longer oil prices. Even if the conflict is resolved, the impacts will continue to be seen for some time, as infrastructure will need to be rebuilt and trade routes will need to be re-adjusted.

Bottom line: With the stalemate in the Strait of Hormuz appearing no closer to a resolution, we expect oil prices to remain elevated, and we continue to employ hedges in our portfolios to counter lingering uncertainty.

Europe

Fiscal problems in Europe are materializing in the form of higher bond yields, most notably in France. This is giving some observers flashbacks to the Eurozone sovereign debt crisis of the early 2010s, when deficit spending, excessive lending, and the Global Financial Crisis (GFC) caused several European nations to be unable to pay their debts, prompting intervention from the International Monetary Fund (IMF) and European Central Bank (ECB) and threatening the unity of the European Union (EU). Our evaluation is that the current situation, while worrisome, is not the same. While bond yields are currently elevated in both the United States and Europe, the underlying drivers are different—in the U.S., they are largely a function of higher productivity, while in Europe, they are a sign of both continent-wide economic headwinds and country-specific fiscal troubles. Regardless of the root cause, however, we expect these elevated yields to persist and perhaps move even higher. That is because the bond market is supposed to be a safe haven when investors get spooked, but it is not acting that way currently. Higher yields on European bonds also highlight one of the disadvantages of the EU compared to the United States and other countries—the EU is not, in fact, a unified state, but rather a collection of independent countries, the economic and fiscal health of which may vary quite widely at any given time. That can create the potential for a contagion effect, which is what we think we are seeing now. In our view, the situation still appears manageable at this stage—but bond markets are clearly wary, and it is certainly something investors should be keeping their eyes on.

Bottom line: While we are somewhat concerned about the European debt situation, we do not view it as comparable to the sovereign debt crisis of the early 2010s.

Equities

How have small and midcap exposures held up during the latest artificial intelligence (AI) surge? While performance over the past month or so hasn’t been as strong as hoped, they have performed well for most of the year. Going forward, the big question is: what does the interest rate outlook look like? Rate hikes tend to impact small and midcap companies proportionately more than large-cap companies, so multiple rate increases would be a negative. On the other hand, profit margins and consumer spending still appear supportive of small and midcap gains. Small and midcap valuations also look more attractive than the larger Tech names. All together, we remain overweight small and midcaps in expectation of the growth story broadening out beyond just the top AI firms. Small-cap firms in Resources and related sectors have the potential to benefit from a commodities boom, while companies across the small and midcap spectrum stand to benefit more from AI-related efficiencies than large and megacap companies, which already have robust capabilities as a result of their large workforces and overall size and scale. To put it another way: an AI agent can make a bigger difference on a team of 15 than it could on a team of 500.

Bottom line: We still expect to see some momentum for small and midcap companies going forward, though much will depend on how many rate hikes we see from the U.S. Federal Reserve (Fed).

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled The broadening summer rally confronts a higher-rate reality.

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Originally Posted October 13, 2026 – Hedging against headline risks

Source

¹Luke Fountain, “Trump says U.S. will not attack Iran before midterm election,” CNBC, October 8, 2026.