Easy financial conditions are underpinning markets, but they are also quietly reducing the political cost of sparking geopolitical conflict.

Rich Privorotsky, head of Goldman Sachs' Delta-one trading desk, noted in an August 17 report that when the S&P 500 sits at record highs and financial conditions are exceptionally loose, the market's restraining influence on policymakers actually diminishes significantly—"when markets are booming, it actually becomes easier to wage war."

This observation cuts straight to the tail risk the market is most prone to overlooking right now. He explicitly cautioned that geopolitical tail risk should not be underestimated, and with the cost of extreme tail hedging tools at historic lows, investors now have a window to build protection at a minimal price.

Analysis suggests that despite escalating tensions in the Middle East and attacks on shipping vessels, the market has shown little reaction—the S&P 500 has climbed back to highs, the VIX hovers near 14, and financial conditions are among the loosest seen in recent years. This very "desensitization" may be the signal that worries Privorotsky the most.

On overall strategy, Privorotsky maintains a risk-on stance, recommending holding nominal assets, shorting bonds, buying cheap volatility protection, and favoring financials, semiconductor capital expenditure, industrials, and cyclical sectors.

Geopolitical Risk Underpriced, Elevated Markets Lower the Conflict Threshold

This is the most cautionary element of Privorotsky's report.

His baseline view is that with midterm elections approaching, policymakers retain economic rationality beneath their rhetoric. However, he then introduced a deeper logic—"when markets are thriving, the market's grip on decision-makers weakens; when the S&P 500 is at all-time highs and financial conditions are loose, waging war actually becomes easier."

This implies that precisely at the moment when markets are calmest and investors most complacent, geopolitical risks may be systematically underpriced. The ultimate direction of the Middle East situation remains unclear, oil inventories sit at unusually low levels, and while oil prices in the $80–90 range may be tolerable, upside risks cannot be dismissed.

Privorotsky's conclusion: we cannot afford to be complacent about geopolitical risk. The good news is that extreme tail risk hedging instruments are currently at historically cheap levels, offering investors a chance to secure protection at very low cost.

His advice: maintain risk appetite, add convexity exposure, avoid or short bonds, buy cheap protection, and let trends run their course.

Market Back at Highs, July Deleveraging Largely Complete

In the report, Privorotsky pointed out that the widely acknowledged position unwinding and deleveraging process seen in July has now largely run its course. Current total leverage and net leverage are both at healthier levels, with overall leverage in the system having declined notably.

In terms of market performance, the S&P 500 has largely recovered to its highs, the VIX remains near 14, and financial conditions are close to multi-year extremes. With options expiration approaching this week and the market near highs, most covered call strike prices have been breached, yet current positioning remains below historical norms at these levels—suggesting investors may face forced buying pressure in September.

Privorotsky believes the near-term upside tail risk remains cheap, with Euro Stoxx index volatility in single digits and the VIX around 14, and he recommends holding upside option exposure in the short term.

AI Remains a One-Way Trade, but Free Cash Flow Is the Ultimate Test

On the artificial intelligence sector, Privorotsky's view is that AI's biggest beneficiary is the broader market, not any single company. He argues that the market is moving along a one-way track—the cost per unit of computing power keeps falling, while the practical value generated per dollar of output keeps rising. This trend will ultimately benefit nearly all industries and companies, making most business models more profitable.

He specifically noted that the true winners may be those who capture AI's benefits at the lowest cost, rather than those who invest the heaviest. The recent strong earnings season has dispelled some of the market's earlier pessimism.

However, Privorotsky remains cautious on the outlook for hyperscale cloud providers, setting that debate aside for now. He made clear he still adheres to the "Cuba Gooding Jr. principle"—if free cash flow doesn't show up, he won't buy.

Long-End Rates Under Quiet Pressure, Fed May Be Forced Back to Hiking

On interest rates, Privorotsky characterizes this as the market's "only true sore spot" at present. He noted that the weakness in US long-end rates does not stem from any single policy decision, but rather reflects structural supply pressure—against a backdrop of 6% to 7% fiscal deficits, the persistent large-scale issuance of US Treasuries and investment-grade bonds creates real crowding-out effects, term premiums are rising, and real yields are at extremely elevated levels.

He also raised a non-consensus view: if the Federal Reserve persistently misses its inflation target, it will ultimately face a credibility risk. He observed that Hammack, Logan, and Kashkari already voted for rate hikes in July, and the continued rise in long-end rates may eventually force the Fed committee to act.

"Perhaps the Fed will eventually hike to restore credibility," he wrote, "the front end is anchored by policy, but the long end is not. A flatter curve might actually help."

On overall strategy, Privorotsky recommends holding nominal assets—the S&P 500, gold, shorting bonds—and including cheap VIX call options or spread strategies in the portfolio. He favors financials, technology tied to semiconductor capital expenditure, industrials, and broad cyclicals, while avoiding bond proxies lacking pricing power, including consumer staples, telecoms, and REITs, and prefers pairing those shorts with long healthcare positions.