Measuring The Market Impact Of Geopolitical Risks

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by: BlackRock

Estimating how - and exactly which - geopolitical events may affect markets and portfolios can be a challenge. Isabelle explains how our new BlackRock geopolitical risk dashboard can help.

Italian elections, Middle East tensions, trade frictions…geopolitical risks abound. Yet estimating how - and exactly which - geopolitical events may affect markets and portfolios can be a challenge.

Our new BlackRock geopolitical risk dashboard provides a starting point for framing these hard-to-quantify variables. It's a hub where we identify and share our analysis of 10 geopolitical risks, the likelihood of their occurrence and potential market impacts.

A key challenge is estimating how much is already priced in. As a proxy for this, we measure market attention to overall geopolitical risk using our global BlackRock Geopolitical Risk Indicator (BGRI) as a gauge. The BGRI tracks the frequency of words that relate to geopolitical risk in analyst reports, financial news stories and tweets, taking into account positive and negative sentiment in the text. The higher the index score, the more markets are focusing on geopolitics, and vice versa.

It currently indicates market attention to geopolitical risk has picked up but remains below historic highs. See the chart below:

Our dashboard also features individual BGRI scores for each of our top-10 geopolitical risks, as well as a set of assets most likely to be sensitive to each risk scenario.

How do we estimate the likelihood of our top-10 risks?

Our geopolitical experts identify potential escalation triggers for each and then assess the most likely manifestation of the risk over the next six months. The relative likelihood of each event is then measured versus the remaining risks.

What do we seeing heating up?

Rising U.S.-China trade tensions have caused us to raise the relative likelihood of the risk related to U.S.-China relations. More recently, political developments in Italy have rekindled risks of European fragmentation.

What's moved to the back burner (for now)?

There has been a significant reduction in the risk of U.S. military action against North Korea in the wake of dialogue between North Korea and South Korea and a possible summit between U.S. President Donald Trump and North Korea's Kim Jong-un. Yet the tentative nature of the meeting illustrates the risk of bumps in the road of any negotiation process, and the prospect of an ultimate resolution remains uncertain.

What other risk is garnering high market attention of late?

Gulf tensions are in focus as the U.S. steps back from the multi-party deal intended to curb Iran's nuclear ambitions. Other factors at play: an increasingly confident and hard-line Saudi Arabia; Iran expanding its influence throughout the region; and the direct involvement of Russia in Syria. Overall, we expect Saudi-Iran tensions to increase and regional proxy fights to escalate, but see global market impact as limited.

The effect of geopolitical shocks on global markets often is short-lived, according to our analysis of asset price reactions to 50 risk events since 1962. Yet the impact tends to be more acute and long-lasting when multiple shocks happen in close succession or when the economic backdrop is weak, we find. We are not there today, and see U.S. Treasuries and gold providing a buffer against risk asset selloffs triggered by geopolitical crises.

Keep in mind that tracking geopolitical risks and their market impact is as much an art as a science, and we are continuously updating our risk scenarios and fine-tuning our methodologies.

This post originally appeared on the BlackRock Blog.