Downside From Davos - It's A Riskier World Than 2012 - How To Benefit

Includes: BIO, KIE, SPY, TAN, XLV
by: Far Horizon

As the "Who's Who" of international business meets at the World Economic Forum in Davos, the WEF has published the eighth edition of its Global Risk Report. This report, produced in collaboration with a group of insurance companies and universities, provides a comprehensive and far reaching view of the global risk landscape, with the shared view of the risk industry and the academics.

The summary - the world of today is higher risk than 12 months ago.

The full report is available from the WEF website.

Investors can benefit from studying this work in two ways - understanding the risk landscape to make better 'risk on, risk off' decisions, and looking for opportunities that arise. One man's risk becomes another man's reward - which industries will benefit from increased demand in the longer term?

The key risks are mapped on a consistent basis, generating a dynamic picture of the global risk landscape, which tracks the change in probability year on year. Most of the top risks identified are assessed as both more likely to occur, and more significant in scale than a year ago, with only a glimmer of good news around liquidity and the risk of conflict arising from rogue states.

As investor confidence is soaring, and shown by the VIX and the S&P 500 index, the academic and risk management community thinks the opposite.

The Global Risks Perception Survey was conducted in September 2012. Over 1,000 experts responded to evaluate 50 global risks from five categories - economic, environmental, geopolitical, societal and technological. For each global risk, survey respondents were asked, "On a scale from 1 to 5, how likely is this risk to occur over the next 10 years?" and "If it were to occur, how big would you rate the impact of this risk?"

The top five risks by impact are seen as:

  1. A major systemic financial failure.
  2. Water supply failure,
  3. Chronic fiscal imbalance.
  4. A crisis in food supply.
  5. Further diffusion of weapons of mass destruction.

The survey also explores the connection between different risk scenarios, asking the respondents to link risks, which they see as being connected, and building a picture of which risks are related most strongly to each other.

The the most obvious and immediate concern are the correlated risks of systemic financial failure and fiscal imbalance. Concern centers around the slow emergence of the world's economy, which is expected over 2013, with continued exposure to government debt, and challenges arising from policies such as quantitative easing.

The report identifies the need for government spending controls - required to rebalance government debt levels to fractions rather than multiples of GDP. Deferral of this belt tightening in the hope of stimulating growth is identified as enhancing the risk landscape.

Associated to this theme is the threat of a hard landing of a major developing economy - although since the survey date, news on this front, especially from China has been positive.

Climate change takes a prominent role, with expectation of an enhanced exposure to severe weather, increasing the likelihood of natural disasters, and shortages of food and water supplies. The report cites estimates of the economic cost of the 2011 Thai floods of $30bn, and hurricane Sandy - $70bn as examples of the increasing costs of a changing climate, and calls for more investment in climate adaptation through technology and infrastructure.

Another key risk that is explored is termed 'digital wildfires,' a situation where social media is used to propagate misinformation with potentially damaging effects - one key example is the rumor that the NYSE was flooded during hurricane Sandy. Misinformation can be easily used to manipulate public perception, and this can have a catastrophic effect - think how stock prices react to news feeds.

Far scarier is the prospect of the continued development of antibiotic resistant bacteria, with consideration of the consequences of antibiotics being rendered ineffective through over use. One study shows that the bacteria Staphylococcus aureus, resistance to the antibiotic meticillin (MRSA) is between 10%-25% of cases in much of Western Europe.

The report quotes Dr Margaret Chan, Director-General of the World Health Organization.

"A post-antibiotic era means, in effect, an end to modern medicine as we know it. Things as common as strep throat or a child's scratched knee could once again kill."

While this seems alarmist, there are already significant consequences attributed to antibiotic resistant bacteria, in the U.S. these are blamed for causes of a majority of 99,000 deaths each year from infections acquired in hospitals., adding healthcare costs of $21-$34 billion annually.

Industries to benefit.

Taking a long-term view of demand, there are several sectors that should benefit from investment in managing these risks.

  1. Property Casualty Insurers and Reinsurers are a key potential beneficiary of climate change, as the costs of natural disasters rise the demand for insurance products will increase, and while volatility of earnings might be an issue, the margins for well capitalized long-term players should increase. Having underperformed in recent years due to asset problems, the industry trades at a discount to book value.
  2. Food producers, distributors and food and water technology companies stand to benefit from climate-related supply squeeze. Producers in countries closest to the major population centers are particularly interesting, such as Australian and NZ agribusiness, which is set to take a more prominent role as a supplier to China.
  3. Pharmaceutical companies, especially those with antibiotic product development capabilities are an obvious winner of the need for continued investment into antibiotic resistance.
  4. The green industry. While investments in green technology have been highly volatile, in the long run the focus of governments and consumers is likely to shift further to penalize products with a high environmental impact. Stock analysis of investments in sensitive industries should include a consideration of climate impact. Clean energy and low emissions technology will increasingly be reflected in stock performance.

While the benefits might take some time to materialize, the long-term investor should consider adding weight to exposure to these sectors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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