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BlackRock (BLK) is the world's largest publicly traded investment management firm. As of September 30, 2016, it had assets under management, or AUM, of $5.1 trillion. This is ~7% of the total assets under management across the globe.

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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 the most recent point. 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 the most recent point. 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.

European fragmentation

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Political uncertainty points to a sustained increase in European risk premia:

  • Elevated and persistent political uncertainty justifies a structural discount on European equities, in our view. We expect bank stocks to be more sensitive to political headlines than other sectors. Investors were already expressing reservations toward the sector well before the Italian election because of structural impairments to European banking business models.
  • Investor sentiment toward European equities has been declining, with steady outflows from the asset class. Earnings momentum in Europe has also lagged other regions in 2018. It’s too early to assess the full economic impact of recent developments, but looming risks threaten to slow regional economic activity and investment, further weighing on earnings expectations for European companies.
  • The European Central Bank (ECB) in June announced that it would end net asset purchases this year, capitalizing on a window of opportunity to act independent of the situation in Italy. Notably, markets focused on the ECB’s indication that it will not lift rates until the third quarter of 2019, viewing such a specific timeline as dovish. The ECB will keep reinvesting the proceeds of maturing bonds, thereby maintaining a significant presence in the market. The announcement triggered the largest single-day euro depreciation versus the U.S. dollar in more than two years.
  • Looming risks look set to keep credit and sovereign spreads elevated in Italy and peripheral Europe. Yet even after recent spread widening, the all-in yields available on peripheral bonds offer investors scant compensation for the associated volatility, in our view. European corporate debt is looking more attractive for euro-based investors after a recent selloff.

Our bottom line: Elevated political uncertainty points to a sustained increase in European risk premia. We anticipate higher volatility in European assets as investors grow more sensitive to any indication that the economic cycle is ending. Yet we don’t see European risks alone as significant enough to dent our outlook for the sustained global economic expansion to roll on – unless they intensify dramatically.

View our previous focus risk
May focus risk
Gulf tensions (comments as of May 2018)

The BlackRock Geopolitical Risk Indicator (BGRI) for our Gulf tensions risk has ticked up. The current reading is around one standard deviation above the historical average, but well short of previous peaks. We expect limited impact on global markets. Gulf markets are vulnerable but have a small weighting in emerging equity and bond indexes.

Overall, we expect Saudi-Iran tensions to increase and regional proxy fights to escalate. At the heart of this dynamic: the U.S. withdrawal from the Iran nuclear deal; an increasingly confident and hardline Saudi Arabia backed by a hawkish White House; Iran expanding its influence throughout the region; the direct involvement of Russia in Syria; and elevated oil prices.

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    We expect the U.S. withdrawal from the Iran nuclear deal to be a significant blow to the Iranian economy and to the relationship between the U.S. and its European allies. It will further exacerbate geopolitical tensions in the Gulf. On May 8, President Trump announced his decision to cease U.S. participation in the Joint Comprehensive Plan of Action (JCPOA; Iran nuclear deal) and to re-impose, following a wind-down period, all U.S. sanctions lifted or waived in connection with the deal. This decision reflects the maximum steps the U.S. could have taken. The other parties to the deal (Iran, Europe, China, and Russia) have announced they remain committed to the agreement, but U.S. sanctions will likely curb economic activity and investment in Iran. This reduces incentives for Iran to continue meeting its deal obligations. We see the greatest impact of U.S. withdrawal on the Iranian economy, on oil supply and on European companies with economic interests in Iran.

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    We expect regional proxy conflicts between Saudi Arabia and Iran to intensify. We view direct conflict between Riyadh and Tehran as unlikely, but the potential for escalatory accidents abounds. These include a missile strike on Riyadh (or on Saudi energy infrastructure) originating from Yemen; an accidental clash between U.S. and Russian forces in Syria; direct conflict between Israel and Iran in Lebanon or Syria; or an eventual Israeli or U.S. pre-emptive strike on Iran’s nuclear capabilities. We currently see a low chance of this fourth outcome but the market impact of any such action would be high, with potential for a global risk-off move and an oil-price spike on fears of supply disruptions.

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    Saudi Crown Prince Mohammad bin Salman (MBS) looks set to further consolidate his power and gradually implement his ambitious reform agenda. There are risks: We expect uncertainty around the Saudi succession process, and we see reforms being rolled out in a piecemeal fashion. MBS’s broad-based popularity and support among Saudi youth buy him time, but he has many irons in the fire: managing Iran, Qatar, Yemen, Trump, and his own family. High oil prices may reduce incentives to move ahead on structural reforms to liberalize the economy. If the reforms backfire and lead to domestic instability, we expect oil prices to rally and Gulf markets to sell off.

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.

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 0.2 standard deviation in a week. We use data from 2003 to the most recent point.