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BlackRock geopolitical risk dashboard

Introduction and highlights
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Notes:

Background

Escalation triggers

Potential market implications

Market impact
Risk-sensitive assets and their historical betas

Sensitive asset
Source: BlackRock Investment Institute, with data from Thomson Reuters. Notes: The financial assets shown are those we have identified as being historically sensitive to swings in the selected BGRI. Our gauge of sensitivity is the correlation between returns on these assets and weekly moves of 0.2 standard deviations or more in the BGRI from 2003 to May 2018. The arrows show the historical direction of the asset response. The sensitive assets are shown for illustrative purposes only; markets may react differently in the future. The above is not intended to represent the performance of any specific product or security, nor is it a recommendation to invest in any particular investment strategy or product.

Relative likelihood and market impact of risks


Focus risk
{{chosenRisk.name}}
BlackRock Geopolitical Risk Indicator

Risk scenario description:

Our view:

Notes:

Background

Key recent developments

Escalation triggers

Potential market implications

Risk-sensitive assets
{{chosenRisk.asset1}}
{{chosenRisk.asset2}}
{{chosenRisk.asset3}}
{{chosenRisk.asset4}}
Source: BlackRock Investment Institute, with data from Thomson Reuters. Notes: The financial assets shown are those we have identified as being historically the most sensitive to swings in the {{chosenRisk.name}} BGRI. We use data from 2005 to May 2018. We measure the sensitivity by calculating the correlations between returns on these assets and upward weekly moves of 0.15 standard deviation or more in the BGRI. The arrows show the historical direction of the sensitive asset response. The sensitive assets are shown for illustrative purposes only; other factors may have been at work in the past and markets may react differently in the future. The analysis is not intended to represent the performance of any specific product or security, nor is it a recommendation to invest in any particular investment strategy or product.

Gulf tensions

Highlights:

  1. 1.

  2. 2.

  3. 3.

Oil’s slippery slope

The recent rise in oil prices to four-year highs is a reminder of oil’s sensitivity to regional geopolitics. Highlights:

  • The oil market is particularly tight right now. Inventories are below their five-year average and OPEC production cuts have corrected the supply glut that depressed prices in 2016 and 2017. Prices are hovering near multi-year highs – in part driven by increasing geopolitical tensions.
  • Why do oil prices matter so much? Rising oil prices currently exert only a tiny drag on global growth, in our view. We see U.S. fiscal stimulus supporting above-trend global growth – and lingering economic output gaps in other parts of the world pointing to room to run in the current cycle. A persistent rise in crude to $100/barrel or more – driven by supply cuts or geopolitical shocks – would hit consumption and sentiment harder. The economic blow could be partially offset by energy-sector spending.
  • For emerging markets, oil is currently trading at the high end of what we call a “sweet-spot range” of $50 to $80 a barrel. This range gives the majority of oil exporters fiscal maneuvering room while keeping intact their willingness to implement structural reforms. Any further rise in the oil price, and the appetite for reforms generally starts waning.
  • Increased revenues from oil exports should help narrow budget deficits in the region. This could deliver a reprieve from domestic economic concerns, but may also embolden the foreign policies of regional actors in the near term, leading to increased defense purchases. A recent currency collapse in Iran and U.S. withdrawal from the nuclear deal make elevated oil prices much more important to domestic stability.
  • A slump in oil prices in the second half of the year could direct Iran and Saudi Arabia’s attention to domestic economic issues. Consistently low oil prices in 2017 influenced budget decisions in Saudi Arabia to boost government spending and slow the country’s austerity drive, in an effort to lift the economy out of recession. This year’s protests in Iran were prompted in part by a stagnating economy and rising cost of living. Similar forms of unrest are not out of the question in Saudi Arabia.
  • MBS needs an initial public offering (IPO) of Saudi Aramco to fund the country’s economic transformation – and a successful IPO requires high oil prices. The international listing will likely be delayed to 2019, when higher crude prices are expected to drive a more favorable valuation.
  • Gulf countries will have to grapple with oil prices that are lower relative to history due to U.S. shale production (the U.S. Energy Information Administration forecasts U.S. production will top 11 million barrels per day in 2018) and the long-term trend of reduced dependency on fossil fuels.
View our previous focus risk
March focus risk
American protectionism (comments as of March 2018)

American protectionism is our geopolitical focus risk in March. U.S. President Donald Trump has used strong protectionist rhetoric — as a businessman, as a candidate and now as president. Yet Trump took only dilatory action during his first year in office — setting the stage for a more eventful 2018. Several U.S. trade probes have come to a conclusion, an investigation into Chinese trade practices has shaken markets, and North American Free Trade Agreement (NAFTA) talks are limping along. We outline three scenarios on how this could play out.

  1. 1.

    Words into action (base case)

    Our base case is that U.S. protectionist rhetoric turns into meaningful action this year. NAFTA negotiations are extended through the Mexican and U.S. midterm elections. We’ve seen Trump taking material action on steel and aluminum imports, although myriad exceptions have largely taken the sting out of them. The U.S. clearly has China in its sights, as seen by recently announced actions against Chinese companies accused of violating intellectual property (IP) rights. We see the announced tariffs on up to $60 billion of Chinese imports largely as an opening gambit for negotiations with Beijing. The actions also play to the sentiments of Trump’s base ahead of the U.S. midterm elections in November. We expect China to retaliate in measured fashion, leading to some tit-for-tat trade actions, but to work hard behind the scenes to avoid a trade war. A comforting thought: The negotiations are led by seasoned pros on both sides.

    Potential market impact: Limited trade action is unlikely to affect sound market fundamentals, in our view. We see any volatility spikes around protectionist actions as short-lived and believe investors are still rewarded for taking on risk in this environment.

  2. 2.

    Trade trash talk

    Our base case is that U.S. protectionist rhetoric turns into meaningful action this year. NAFTA negotiations are extended through the Mexican and U.S. midterm elections. We’ve seen Trump taking material action on steel and aluminum imports, although myriad exceptions have largely taken the sting out of them. The U.S. clearly has China in its sights, as seen by recently announced actions against Chinese companies accused of violating intellectual property (IP) rights. We see the announced tariffs on up to $60 billion of Chinese imports largely as an opening gambit for negotiations with Beijing. The actions also play to the sentiments of Trump’s base ahead of the U.S. midterm elections in November. We expect China to retaliate in measured fashion, leading to some tit-for-tat trade actions, but to work hard behind the scenes to avoid a trade war. A comforting thought: The negotiations are led by seasoned pros on both sides.

    Market impact: This scenario is the most positive for risk assets, particularly for emerging markets. We see EM stocks outperforming their developed market peers within the context of a broad global equity rally.

  3. 3.

    America the protectionist

    There is a possibility the U.S. turns truly protectionist. This could include imposing major tariffs on a variety of goods and directing trade actions at China out of frustration over an ever-growing trade deficit, limited market access and perceived inaction on North Korea; withdrawing from NAFTA; pulling out of other bilateral trade agreements; or further undermining the World Trade Organization by either ignoring its rulings on the administration’s tariffs or withdrawing altogether. Such a drumbeat could rattle markets because the challenge to the global trade order would emanate from the very center: the world’s largest economy and erstwhile champion of free trade. It could trigger a trade war with China, the globe’s second-largest economy. Chinese retaliation could extend beyond trade measures. It could leverage its position as the top foreign holder of U.S Treasuries, slowing down or halting its purchases.

    Market impact: This scenario has the most adverse outcome for global risk assets. We would expect EM currencies and equities to be hit first, triggering a global flight to perceived safe havens such as U.S. Treasuries. Second-order (and far longer-term) implications are more nuanced, but we note the potential for supply chain shocks to increase inflationary pressures. This, in turn, could increase the pace of the Federal Reserve’s monetary policy tightening.

General market considerations

China trade actions: We see little risk of the trade actions against China leading to a sustained selloff in Chinese equity markets. Such plans have been well-telegraphed. We do see a risk of an escalating tit-for-tat trade war in case of more drastic action. This could lead to a change in investor sentiment and drag down Chinese risk assets. China’s steel and aluminum sectors only send a low single-digit share of production to the U.S., so Trump’s tariffs are unlikely to have much effect. Any decline in Chinese steel exports would anyway be dwarfed by Beijing’s ongoing efforts in China to cut capacity due to environmental and overcapacity concerns.

NAFTA withdrawal: A U.S. withdrawal from NAFTA could have a similar effect on Mexican and Canadian markets as the 2016 Brexit vote had on UK assets: sharp currency falls, followed by a decline in bond yields and underperformance of domestic-focused stocks, before a central bank steps in to stem inflationary pressures. We see global car makers and suppliers hit hardest by a NAFTA termination. Trade disruptions could also result in reduced demand for U.S. agricultural products and slowing capital expenditure in the industry. Transport and logistics are among the other sectors that may be hit, particularly freight carriers.

How it works

The BlackRock Geopolitical Risk Indicator (BGRI) continuously tracks the relative frequency of analyst reports, financial news stories and tweets associated with geopolitical risks. We have used the Thomson Reuters Broker Report and the Dow Jones Global Newswire databases as sources, and recently added the one million most popular tweets each week from Twitter-verified accounts. We calculate the frequency of words that relate to geopolitical risk, adjust for positive and negative sentiment in the text of articles or tweets, and then assign a score. We assign a much heavier weight to brokerage reports than to the other data sources because we want to measure the market’s attention to any particular risk, not the public’s.

The BGRI is primarily a market attention indicator, gauging to what extent market-related content is focused on geopolitical risk. The higher the index, the more financial analysts and media are referring to geopolitics.

We also take into account whether the market focus is couched in relative positive or negative sentiment. For example, market attention on geopolitical risks was extremely high during the Arab Spring of 2011. Much of the attention was focused on the potentially positive effects of the regime changes, however. The adjustment for this positive sentiment mitigated the Arab Spring’s impact on the BGRI’s level. Sentiment adjustment also helps us avoid overstating geopolitical risk when risks actually are being resolved.

Here’s the step-by-step process:

  1. BGRI attention: This is the market attention score. The global BGRI uses words selected to denote broad geopolitical risks. Local BGRIs identify an anchor phrase specific to the risk (e.g., North Korea) and related words (e.g., missile, test). A cross-functional group of portfolio managers, geopolitical experts and risk managers agrees on key words for each risk and validates the resulting historical moves in the relevant BGRI. The group reviews the key words regularly.
  2. BGRI sentiment: This is the sentiment score. We use a proprietary dictionary of about 150 “positive sentiment” words and 150 “negative sentiment” words. We use a weighted moving average that puts more emphasis on recent documents.
  3. BGRI total score: This is BGRI attention — (0.2 * BGRI sentiment). We want the indicator to fundamentally measure market attention, so we put a much greater weight on the attention score. A 20% weight of the sentiment score can mitigate spikes at times when risk may actually be receding.
  4. Meaning of the score: A zero score represents the average BGRI level over its history from 2003 up to that point in time. A score of one means the BGRI level is one standard deviation above the average. We weigh recent readings more heavily in calculating the average.

Risk likelihood and impact chart

The risk likelihood and impact chart shows our assessment of the relative likelihood of our top-10 risks and the potential severity of their market impact. Our geopolitical experts identify potential escalation triggers for each risk and then assess the most likely manifestation of the risk over the next six months. The relative likelihood of each event (vertical axis) is then measured relative to the remaining risks. For example, we currently rate {{chosenRisk.name}} as having a relatively high likelihood, whereas we see {{chosenRisk.name}} at the lower end of the scale. The severity of market impact (horizontal axis) is based on Market-Driven Scenarios (MDS) analysis from our Risk and Quantitative Analysis group and estimates the one-month impact of each risk on global equities (as measured by the MSCI ACWI) if it were to come to pass. For example, we currently see {{chosenRisk.name}} having among the highest potential market impact, whereas we expect the market effects of {{chosenRisk.name}} to rank at the bottom. Colored lines and dots show whether BlackRock’s Geopolitical Risk Steering Committee has increased (green) or decreased (red) the relative likelihood of any of the risks from our previous update. The chart is meant for illustrative purposes only.

Market impact – overall

Our MDS framework forms the basis for our scenarios and estimates of the one-month impact on global equities. The first step is precise definition of our scenarios – and well-defined catalysts (or escalation triggers) for their occurrence. We then use an econometric framework to translate the various scenario outcomes into plausible shocks to a global set of market indexes and risk factors.

The size of the shocks is calibrated by various techniques, including analysis of historical periods that resemble the risk scenario. Recent historical parallels are assigned greater weight. Yet historical data are not the only input to our analysis. Some of the scenarios we envision do not have precedents – and many have only imperfect ones. This is why we integrate the views of BlackRock’s experts in geopolitical risk, portfolio management, and risk and quantitative analysis into our framework. See the 2018 paper Market Driven Scenarios: An Approach for Plausible Scenario Construction for further details. The BGRI’s risk scenario is for illustrative purposes only and does not reflect all possible outcomes as geopolitical risks are ever-evolving.

Market impact – sensitive assets

For each of our top-10 risks we identify assets that historically have been sensitive to upward movements in their respective BGRI, as measured by the correlation of returns to these assets and the BGRI when the BGRI rose more than 0.15 standard deviation in a week. We use data from 2005 to May 2018.