Geopolitics in the age of AI

2026, anticipated to bring stability after the turbulence of 2025, has instead begun with policy upheaval. A series of geopolitical flare-ups across multiple regions has strained alliances, raised military tensions, and reintroduced trade and policy uncertainty. The recent expansion of the U.S. military presence in the Middle East has intensified concerns about the potential for a direct confrontation with Iran, should ongoing negotiations fail. Any escalation, particularly one affecting oil supply routes or leading to a closure of the Strait of Hormuz, would carry meaningful implications for both energy and global financial markets.

Yet despite the rise in geopolitical volatility, markets have not experienced a major pullback. This resilience echoes the market’s behavior during 2025’s disruptive trade environment, highlighting investors’ ability to remain focused on solid economic fundamentals, rather than on headline noise.

Still, the rapidly shifting geopolitical environment adds another layer of complexity for investors. With uncertainty proving persistent, maintaining discipline and a long-term perspective remains essential in navigating the evolving global landscape.

Given the unpredictable nature of geopolitical events, forecasting their short- or long-term outcomes is inherently difficult. While fear of uncertainty can drive investor behavior, history shows that equity market reactions in response to geopolitical shocks are generally brief. The exception occurs when such events materially affect economic fundamentals, central bank actions, or coincide with periods of broader macro weakness.

One example is the 1973 oil embargo, which forced the Federal Reserve (Fed)—already grappling with persistent inflation since the mid-1960s and fiscal strain following the Vietnam War—to sharply raise rates to counter oil-driven price pressures. This drove bond yields higher, slowed the U.S. economy, and weighed heavily on equities until the fall of 1974. Equities did not find a bottom until a steep rate-cutting cycle in 1974-75 revived economic activity.

More recently, the Russia-Ukraine conflict in February of 2022 compounded an already challenging macro backdrop. Post-COVID supply shocks had driven inflation higher globally, and Russia’s invasion triggered a surge in energy prices, adding further inflationary pressures. Ultimately, major global central banks, including the Fed, tightened policy, and economic conditions slowed.

By contrast, Russia’s annexation of Crimea nearly a decade earlier had a limited market impact. Energy prices did not surge, allowing financial conditions to remain stable. There was no central bank intervention; the Fed remained in an extended period of zero interest rate policy, and the European Central Bank kept its accommodative stance. This backdrop of easy monetary conditions helped support economic activity, enabling the stock market to reach all-time highs despite geopolitical uncertainty.

Ultimately, markets typically stay anchored to fundamentals, which generally outweigh short-term uncertainty unless geopolitics disrupts them.

The global AI arms race is one channel through which geopolitics could influence economic and corporate fundamentals. The tech rivalry between the U.S. and China—and other major AI players—is likely to spark geopolitical flare-ups in the near future, as the importance of achieving AI dominance aligns with securing economic strength, military power, and global influence.

In this quest for dominance, reliable access to the resource-intensive AI supply chain (e.g., minerals, energy, semiconductors, infrastructure, talent, capital) is imperative. No country controls the entire AI supply chain. Instead, the supply chain functions as a global network, with various regions specializing in different key AI inputs. This interdependence leaves AI advancement in any given country largely reliant on cross-border collaboration.

Against this backdrop, disrupting or constraining the export of a critical input to slow a region’s AI advancement has become a powerful geopolitical weapon, evident in recent policy actions from the U.S. and China.

While the U.S. has maintained its position as the leading global power, China has rapidly advanced its tech capabilities and demonstrated an ability to innovate, not just to replicate. Notably, China’s ability to deliver high-quality goods at lower cost across various industries, including tech, has prompted the U.S. to respond with policies aimed at slowing China’s AI advancement.

Commanding about 50% of the global semiconductor market, the U.S. has leveraged this strength against China, whose reliance on Western rivals for advanced hardware remains a key vulnerability. Since the Biden administration, the U.S. has imposed—and continually revised—export restrictions on advanced semiconductors, a policy that evolves as geopolitical conditions shift and the “America first” drive to maintain tech dominance intensifies.

Beyond its own restrictions, U.S. policymakers have pressured allies to block China’s potential efforts to bypass U.S. export controls. For several years, the U.S. has pressured the Dutch government to bar ASML—which dominates the global market for extreme ultraviolet (EUV) lithography machines, critical for manufacturing the highest-performing chips that power modern technologies—from exporting advanced chipmaking tools to China. Ultimately, efforts to constrain China’s ability to produce advanced semiconductors ensure its ongoing reliance on Western technology.

While U.S. policy measures have perhaps slowed China’s AI progress, they have not prevented Beijing from continuing to advance. This was evident in last year’s release of China’s DeepSeek AI model, widely viewed as China’s “Sputnik” moment, which triggered a temporary sell-off in U.S. tech-sector darlings after Beijing demonstrated it could deliver a high-performance AI model at a lower cost.

China, after all, has been able to work around U.S. advanced semiconductor constraints by clustering large numbers of lower-grade chips and absorbing the higher energy costs required to run them. Simultaneously, Beijing has used its own geopolitical levers to ease U.S. export restrictions.

China also maintains a dominant position in another critical tech input, rare earth elements, which are used heavily across industries, notably tech and defense, for their magnetic and luminescent properties once refined. While China commands almost 70% of the global market share in rare earth mining, its dominance is greater in rare earth refining and magnet production—over 90% and 98% of global market share, respectively.

Over decades, China has built unmatched expertise and scale in rare earth refining—a complex, labor-intensive, and expensive process—while the rest of the world, including the U.S., has become increasingly reliant on it. This U.S. vulnerability became evident when China retaliated against U.S. tariffs last year, prompting renewed negotiations given both countries’ interdependence in the AI supply chain.

Notably, China recently imposed rare earth export restrictions on Japan in response to Japan’s stance on Taiwan, a sign that China will likely continue to use this policy lever as long as the U.S. and other countries remain dependent.

In fact, recent geopolitical events may have a common theme around the race to AI dominance and restricting rivals’ access to critical resources.

•  U.S. actions in Venezuela/Iran: Recent U.S. military intervention in Venezuela and heightened tensions in Iran have sparked debates about whether the U.S. seeks to restrict China’s oil access, thereby gaining another geopolitical lever against Beijing.
• U.S. actions in Greenland: Beyond its strategic location for monitoring missile activity, there is a debate around Greenland’s mineral wealth and its potential role in global tech supply chains, also emphasizing American efforts to access natural resources, while limiting China.
• China military drills around Taiwan: China recently conducted military drills around Taiwan’s major ports, simulating a potential blockade that would isolate the island. The U.S.’s ongoing reliance on Taiwan, which manufactures roughly 90% of the world’s most powerful semiconductors, leaves U.S. tech vulnerable to potential supply chain disruptions, especially a Chinese-initiated halt to semiconductor exports. 

As long as the U.S. and China remain reliant on one another for key AI inputs, tail risks are somewhat contained. However, reducing this mutual dependence (an effort underway on both sides) could increase tail risks, though the outcome or timing of such an event is essentially impossible to pinpoint. For now, markets may simply contend with ongoing headline risk, which they have grown accustomed to since Liberation Day.

So far this year, the geopolitical landscape has had a limited market impact, as no single event has triggered a crisis in AI and its supply chain. However, as investors navigate an increasingly uncertain environment, slow-building policy actions aimed at advancing national ambitions and curbing rivals’ influence within the AI space should not be overlooked.

The concentration of the U.S. equity market within a few large tech companies—firms that would be substantially affected by restrictions on critical resources and supply chain disruptions—highlights the importance of geopolitical risk to the overall market. A negative event impacting the tech sector or individual firms could reverberate through the broader U.S. and global economies. This is particularly concerning given that tech capital expenditures have become crucial to economic growth, and households, especially those with higher incomes, have significant exposure to tech-concentrated equity markets.

In essence, the chokepoints within the tech sector and its expanding influence on both portfolios and the economy suggest that if U.S./China tech capabilities are undermined by policy actions, geopolitics could transition from a background concern to a catalyst for substantial economic consequences.

The unpredictability of such events underscores the importance of broader diversification as a strategy to mitigate potential shocks and help contain downside tail risk. To reduce reliance on U.S. tech, investors might explore opportunities across various regions, particularly Europe, emerging markets, and the broader U.S. equity market, such as the S&P 493, all of which offer supportive domestic tailwinds beyond just AI. Additionally, commodities, especially precious metals, may gain a more prominent role in portfolios if resource hoarding leads to inflationary pressures or geopolitical behaviors spark bouts of market volatility. Furthermore, industries poised to benefit from heightened geopolitical tensions, such as defense and aerospace, offer additional opportunities for investors.

By adopting a diverse investment strategy, one can better navigate the intricate and evolving landscape of global markets.