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BlackRock geopolitical risk dashboard

Introduction and highlights
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Notes:
Relative likelihood and market impact of risks

The chart above 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 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. 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. Colored lines and dots show whether BlackRock’s Geopolitical Risk Steering Committee has increased (orange) or decreased (green) the relative likelihood of any of the risks from our previous update. We also show our overall measure. Its likelihood score is based on a simple average of our top-10 risks; the market impact is a weighted average by likelihood score. Our February Geopolitical Risk Steering Committee meeting left the likelihood of our risks unchanged but highlighted the following risks:

U.S. – China competition
  • The relationship between the U.S. and China has entered a more competitive phase across economic, ideological and military dimensions. We see these tensions as structural and long-lasting. Investors should not confuse any trade truce with a détente in the overall relationship.
  • There are parallel efforts underway in the U.S. to confront China. The first is focused on trade, with President Donald Trump bent on closing the bilateral trade gap. The second is centered around technology and China’s territorial ambitions — and is driven by the broader U.S. government.
  • The U.S. and China are in a race to dominate the industries of the future. This could lead to the progressive decoupling of the countries’ technology sectors. Beyond technology, risks include an accidental or deliberate clash in the South China Sea and tensions over Taiwan.
South Asia tensions: rising hostilities
  • Tensions between India and Pakistan have risen following a February attack in Jammu & Kashmir by a Pakistan-based extremist group. Subsequent air strikes by Indian forces, the Pakistani response and downed planes mark a significant escalation in hostilities.
  • We see further escalation by Pakistan as unlikely. Any large-scale attack would trigger increased international pressure on Islamabad, further antagonize India and stress Pakistan’s already weak economy.
  • India PM Modi’s response to the Kashmir attacks will support his electoral prospects. But we believe the electorate’s dissatisfaction with the economy and unfulfilled 2014 campaign promises by the ruling BJP party make an opposition victory an underappreciated risk.
European fragmentation: focus on Brexit
  • Europe has us worried. The list of policy and economic challenges keeps getting longer, and we are concerned that Europe has limited policy room to maneuver should the economy slip into recession. Confrontation between Italy and the European Commission has receded for now.
  • UK Prime Minister Theresa May appears to be pursuing a strategy of running down the clock in the hope that fears of either a no-deal Brexit or a long delay to the process will enable her to muster sufficient support to pass a deal through UK Parliament close to the final hour.
  • We see a three-month delay in the process as likely. Further delays are more problematic given a newly elected European Parliament is due to be seated on July 3. We view a no-deal exit as unlikely, but cannot rule it out as it is the default option unless something else is agreed.
LatAm policy: from proposal to policy
  • We focused last year on the likelihood that voters in Mexico and Brazil would favor anti-establishment candidates in their respective national elections. We worried about a reversal in the trend toward pro-business, technocratic governance — a shift that could scare off foreign investors.
  • This year is about concrete policy. Brazil’s government is finding some success in addressing the country’s fiscal ills. In Mexico, the president’s high approval rating is creating space to pursue an ambitious agenda that could have a significant impact on fiscal policy.
  • We see October elections in Argentina as crucial for the country’s economy — with incumbent President Mauricio Macri likely to face off against former president Cristina Kirchner. We worry about a protracted crisis in Venezuela increasing the risk of military confrontation.
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.

Our global BlackRock Geopolitical Risk Indicator has ticked up recently, driven by heightened market attention to our European fragmentation and U.S.-China competition risks. See the Global overview chart. We view recent declines in attention to our Global trade tensions risk as a sign that investors may be growing complacent about the risk and impact of trade conflicts.

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.

Market impact

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. 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 details. The BGRI’s risk scenario is for illustrative purposes only and does not reflect all possible outcomes as geopolitical risks are ever-evolving.

BGRI-adjusted market impact

We enhance our market impact analysis by adjusting the market impact scores to reflect shifting market attention over time. When scenarios are first defined, market shocks are calibrated to reflect what is not already priced in to the market by investors. We call this the original estimate.

As market attention fluctuates, the BGRI-adjusted market impact either increases or decreases in severity based on how market attention evolves. For example, an elevated BGRI level relative to the point at which a scenario is first defined would suggest an increase in investor attention. This would result in a less severe BGRI-adjusted market impact relative to our original estimate. The converse result — in the case of a depressed BGRI level — would also hold. We determine a factor that scales the size of the BGRI move since the date of our original market impact estimate to calculate the BGRI-adjusted market impact. We use a sigmoid function to do so, or a statistical technique that is characterized by an S-shaped curve. We then multiply our original estimate of the market impact by (1 – scaling factor) to reach the BGRI- adjusted market impact score.

Market impact of risks
Source: BlackRock Investment Institute, with data from Thomson Reuters. Notes: The chart shows our estimates of the potential market impact on the MSCI ACWI Index, the grey bar shows our original estimate, the black and orange bars show the adjusted impact based on the level of the BGRI. For example, an elevated BGRI level for a risk would suggest increased investor attention and therefore a lower BGRI-adjusted market impact. Estimates are based on analysis from BlackRock’s Risk and Quantitative Analysis group. See the How it works section and the 2018 paper Market Driven Scenarios: An Approach for Plausible Scenario Construction for details. Some of the scenarios we envision do not have precedents – or only imperfect ones. The scenarios are for illustrative purposes only and do not reflect all possible outcomes as geopolitical risks are ever-evolving. The original estimate for {{chosenRisk.name}} is based on the scenario analysis run on {{chosenRisk.scenarioDate}}. Original estimates are based on the analysis run on the following dates:
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BGRI-specific asset analysis

We are now working to pinpoint assets that have moved along with big changes in individual BGRIs, based on statistically meaningful relationships. We have focused on two risks that are solidly on the market’s radar screen: Global trade tensions and European fragmentation. The chart below shows the historical ranges of three-month returns for selected assets in three-month periods when the respective BGRI rose (the orange bars) or fell (the green bars) by more than one standard deviation. The analysis focused on three dozen assets we believed are related to these two risks.

Risk assets generally underperformed, and perceived safe-haven assets mostly outperformed, in this analysis. We include times the BGRIs stayed at elevated levels over the three-month time frame. The reason: The level of the BGRIs changes over time even if market attention remains constant. This is to reflect the concept that a consistently high level of market attention eventually becomes “normal.” In other words, the effects of elevated BGRIs wash out over longer periods as investors become more accustomed to the risk. Such declines have often coincided with risk asset rallies.

Past performance is not a reliable indicator of future results. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise – or even estimate – of future performance. Notes: The chart shows the 25%–75% percentile ranges (bars) and average three-month returns (dots) for selected assets during rolling three-month periods when the BlackRock Geopolitical Risk Indicator rises or falls by more than one standard deviation. MSCI USD indexes price returns are used for equities, and Thomson Reuters benchmark indexes total returns are used for government bonds.
Focus risk
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BlackRock Geopolitical Risk Indicator

Risk scenario description:

Our view:

Notes:

Background

Key recent developments

Escalation triggers

Background

The U.S. and China are competing to take the commanding heights of technology. This competition is coming to a head in the debate over fifth-generation (5G) cellular networks. This is the high-speed mobile technology that will enable enhanced communications and advanced technology solutions. First adopters of 5G are expected to sustain a significant long-term competitive advantage. The U.S. and China see 5G leadership as a matter of economic and national security and are competing to be the first to deploy the technology and set the standards for 5G globally.

Each country is ramping up its efforts and adjusting its policies to win the 5G race. In China, technology development has the full weight of the national government behind it. The government has laid out a comprehensive plan — Made in China 2025 — to create globally competitive firms and reduce China’s dependence on foreign technology.  In the U.S., by contrast, the development of new technologies is led by the private sector. The U.S. is seen as home to many of the world’s most innovative firms and a strong pool of talent. Silicon Valley operates with limited regulation, coordination or direction from the national government. This enables more diffuse outcomes. Yet the U.S. lacks a coordinated technology strategy, employees of U.S. tech companies often oppose national security contracts, and concern is rising that the U.S. federal government is not doing enough to support research and development.

Key issues

Chinese President Xi Jinping has called for China to surpass the U.S. technologically by 2030, sparking a strong reaction in the U.S. Washington increasingly views advanced technologies as a zero-sum game; any progress made by China is seen as coming at the U.S.’s expense. The current challenge between the U.S. and China is focused on three key issues: national security, economic competitiveness, and global systems dominance.

National security

U.S. government officials fear that technological advances made by China will threaten U.S. national security. The U.S. is taking measures to protect its technology and intellectual property (IP) from transfers, acquisitions and other perceived threats to its national security. These include:

  • Expanded CFIUS authority: Legislation expanded the authority of the Committee on Foreign Investment in the United States (CFIUS) in August 2018 by extending its powers and offering a broader definition of what constitutes “critical technologies.” It does not single out any specific country, but is seen as a tool for countering Chinese attempts to acquire sensitive U.S. technologies and IP. Though it could take more than a year to finalize, the package allows for pilot programs. We could see this having an impact in the short run.
  • New export controls: The Export Control Reform Act of 2018 expands the U.S. export controls process to review joint ventures involving sensitive U.S. technology. In line with this legislation, the U.S. could soon implement new export controls targeting China. A proposed White House Office of Critical Technologies and Security would oversee the interagency process to identify and control new technologies.
  • Visa restrictions: The U.S. administration is considering measures to block Chinese citizens from performing sensitive research at U.S. universities and research institutes over fears they may acquire critical IP. Certain types of projects could become subject to personnel restrictions — particularly those related to technologies central to China’s Made in 2025 strategy.
  • Entity restrictions: The U.S. is moving toward whole entity restrictions — preventing certain companies from doing business in the U.S. or purchasing U.S. components. A ban on telecommunications equipment from Chinese companies would reverberate through the global technology ecosystem. Any blocking of partnerships with foreign countries and companies utilizing Chinese technology would have even greater impact.

China, too, cites national security justifications in its push for technology development. China wants to reduce its dependence on foreign suppliers of digital and communications equipment and, instead, scale up its own capabilities and cyber defenses.

Economic competitiveness

Each country is taking a very different approach toward achieving global technology leadership, and this is spilling over into the trade dispute.

China’s Made in China 2025 strategy is reliant on government subsidies, technology transfer, and the promotion and protection of national champions. China’s state-led model helps to ensure that domestic firms are at the forefront of technology standards and development globally. These practices are clear in its approach to 5G development. Not only have recent government plans earmarked $400 billion for 5G-related investments, but the government has also arranged for its top telecom providers to coordinate on 5G development, and for Chinese Internet platform companies to subsidize 5G rollout.

This is a point of contention for the U.S., which sees Chinese government support as threatening the ability of U.S. companies to compete globally. The U.S. administration has leveraged Section 301 of the Trade Act of 1974 to combat China’s industrial policy and approach to IP. The U.S. has imposed tariffs on $250 billion worth of Chinese imports in accordance with this measure; the Section 301 report mentions “Made in China 2025” more than 110 times. Resolving the existing tariffs in place, as well as the underlying structural issues, is the focus of ongoing negotiations.

Global systems dominance

For nearly half a century, the U.S. has guided the growth and development of the Internet in a model that is characterized by limited regulation, privacy and free speech. Now China is presenting an alternative global systems model with its strategy to transform into a cyber superpower. China’s Internet guides public opinion and fosters economic growth — and is tightly controlled to ensure regime stability.

The competition between the U.S. and China raises the prospect of technological spheres of influence. In the case of 5G, the U.S. administration has made clear that countries and companies may soon be forced to choose sides. We see this leading to tensions between the U.S. and traditional allies, with early signs the UK, Germany and other countries are ready to challenge the U.S. stance.

Implications for markets

We see confrontation over these issues driving the progressive decoupling of the U.S. and Chinese technology sectors, with meaningful implications for the global economy and markets. It makes sense for investors to own selected technology stocks in both the U.S. and China as a result, as we detailed in The heat is on for tech stocks amid U.S.-China cold war. Understanding the full range of the implications will be a core focus of the BlackRock Investment Institute this year.

View our previous focus risk
January focus risk
Major cyberattack(s) (comments as of January 2019)

The BGRI for our Major cyberattack(s) risk is hovering above its historical average, signaling moderate market attention to this risk. Yet cyberattacks are increasing in scope and intensity. We believe markets are underestimating the impact of cyberattacks as four broad trends are converging:.

  1. 1.

    Both the opportunity for attack and the threat posed are rising as the world becomes increasingly digitalized. The increased use of artificial intelligence in business also heightens exposure to cyber risks.

  2. 2.

    The proliferation of Internet-connected devices and availability of open source code have lowered the barriers to entry for cyber crimes. Cyber actors across the world vary in sophistication and capability, ranging from well-funded government agencies to poorly resourced criminal groups and terrorist networks.

  3. 3.

    Digital warfare is becoming an important tool of statecraft, allowing countries to pursue their geopolitical and economic objectives through a wider variety of means. In 2016, NATO expanded its definition of “war domains” beyond air, land and sea to include cyberspace.

  4. 4.

    Defensive capabilities have been slow to evolve. In fact, many organizations have effectively conceded that their infrastructure will be breached, and are instead focusing on minimizing the ensuing damage. In the U.S., more than 50 federal, state and local laws mandate disclosure of cyber breaches to regulators or affected consumers. In Europe, the recently implemented General Data Protection Regulation (GDPR) requires companies to publicly disclose data breaches to national data protection authorities and to individuals when the threat of harm is significant. Failure to do so can result in substantial fines.

As the cyber threat rises, we expect financial markets to pay increasing attention. We see three cyber-related risks and opportunities with a potential market impact: threats to critical infrastructure; threats to specific corporates; and opportunities for cybersecurity.

  1. 1.
    Threats to critical infrastructure
    • Physical infrastructure: Modern economic activity depends on the availability of electricity, meaning any significant interruption to power supply could directly damage assets and infrastructure and force a loss in sales revenue to electricity supply companies and the businesses that rely on them. Our analysis of the potential impact of an attack on the U.S. power grid shows equity market sell-offs, led by utilities and industrials. U.S. Treasuries, the yen and gold would rally. Utility credit spreads would widen, and natural gas rally as an alternative resource.
    • Financial infrastructure: The IMF has now recognized cyberattacks as posing a systemic risk to the financial system. Attacks in advanced economies typically target data or business disruptions, while attacks in emerging markets are more frequently related to fraud. We see the market impact in such a scenario exacerbated by a drop in confidence among market participants. We could see financial stocks leading a global risk-off reaction; Treasuries and gold rallying; and the U.S. dollar benefiting from broad risk aversion and foreign investors liquidating overseas assets to meet margin calls.
    • Technology infrastructure: A cyberattack on technology infrastructure could result in a prolonged outage. This may cause significant disruption and loss of business to industries that rely on these services, as well as reputational damage for the data, storage and internet providers. The effects of such an outage could cascade through supply chains and to other industries such as insurers. We believe large-cap companies would underperform smaller companies, as the top technology service providers and their clients tend to be larger companies. We see the Internet software and services, retail, and insurance industries suffering the most.
  2. 2.
    Threats to specific corporations: Many companies have witnessed sharp share price declines after disclosing cyberattacks in recent years. Attacks have typically targeted companies with large amounts of personal data. Data is a double-edged sword: It has huge value in allowing companies to understand customer trends, but also becomes an enormous burden to protect. The IMF estimated in 2017 that the cost of cyber losses to the U.S. economy range between 0.6% to 2.2% of GDP a year , although this is more than offset by the positive contribution from Internet-based activity. Major financial services and tech companies are often targets but tend to have advanced defenses. We see the utility, energy and defense sectors as among the most vulnerable, although they are now increasing their spending on cybersecurity. Across all industries, risks to watch include companies involved in drawn-out mergers, and firms that rely heavily on third-party vendors.
  3. 3.
    Opportunities in cybersecurity: It is broadly accepted within the technology industry that no cybersecurity provider is able to provide a comprehensive solution — the scope of the threat is too broad. Companies’ chief security officers are charged with patching together a wide range of tools. The existing technology has its faults, but we believe spending is extremely durable given regulatory requirements to demonstrate preventative technology is in place. We find opportunities in four main areas.
    • Cloud computing: Some see cloud technology as vulnerable to an attack, but others believe shifting operations to “the cloud” is one of the best ways to protect against cyberattack. Technology companies are offering two types of cloud-based solutions. The first provides cloud-based network services, making the servers that were previously hackable redundant. The second aims to negate the impact of hack attempts: All of a company’s IP traffic is sent to the cloud, cleaned and returned to the company. This is a thorough method to prevent cyberattacks, but it comes at the cost of speed.
    • Network segmentation: An alternative approach sees companies focusing the bulk of their technology spending on software that “fragments” the network to minimize the damage of a potential cyber risk, rather than looking to prevent hackers from gaining entry altogether. The company is alerted when a hacker has gained access to a very small part of a database/server, and the company can then shut down that part of the operation until the attack is nullified.
    • Identity: User verification is one of the biggest challenges in cybersecurity. Systems are much harder to hack if there is constant verification. This means companies offering solutions that implement regular checks via single sign-on are in increasing demand.
    • Blockchain: Distributed ledgers store information in multiple locations across a single network, meaning that if hackers succeeded in altering one record, it can instantly be identified as different to other records in the system. Blockchain technology is also offering improved data encryption, and producing new and more secure ways of controlling network access, including through multi-signature and multi-party computation cryptography. This can eliminate the need for password-based security systems.

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