Markets are so fixated on inflation that they may miss out on the next big explosion, BlackRock says

Chinese and American flags outside the building of an American company in Beijing, China January 21, 2021.

Tingshu Wang | Reuterss

While investors have been preoccupied with soaring prices, a flare-up in US-China tension could surprise investors, BlackRock warns.

The BlackRock Investment Institute said in a report Monday that its proprietary geopolitical risk indicator has fallen to its lowest level in four years as investors focus more on inflation and economic recovery than geopolitics.

This is a shift in attention due to US-China trade tensions or a nuclear attack in North Korea, both of which have rocked markets in recent years.

“The gauge is in negative territory this year … which means investor attention to geopolitical risk is below the four-year average,” the report said. “As a result, geopolitical shocks could catch investors unprepared.”

Geopolitical risk breakouts could have oversized effects when markets least expect it.

BlackRock Investment Institute

One of the biggest risks that markets may overlook is the separation or “decoupling” of the world’s two largest technological economies. Analysts noted that US President Joe Biden has continued his predecessor’s tough stance on China “with an emphasis on critical technologies,” while Beijing is prioritizing technology autonomy.

“We see a high likelihood that the decoupling of the US and Chinese technology sectors will accelerate in scale and scope, although relatively little attention is paid to the risks arising from the split in Chinese and American technology,” it said in the report.

BlackRock’s geopolitical risk indicator is calculated using two metrics. One is a computerized rating system for positive and negative mentions of geopolitical risks in broker reports and financial news. The second metric is a model of the possible month-long impact of geopolitical events on global assets.

The two measures are then combined to create an index. A positive value close to one indicates that the market performance is in line with the model’s forecast for responding to geopolitical risk. A negative value indicates that markets are moving in a direction opposite to what the model predicts.

While BlackRock didn’t reveal the exact level of the index, the investment firm announced on Monday that the indicator has turned negative this year for the first time since 2017 – meaning that investors’ focus on geopolitical risk is below the average of the last four Years has fallen.

BlackRock is the world’s largest money manager with approximately $ 8.7 trillion in assets under management. The Wall Street giant’s investment firm conducts proprietary research for clients and portfolio managers.

According to BlackRock, the three most likely geopolitical risks of the indicator are:

  1. Separation of the US and Chinese technology industries.
  2. A major cyber attack.
  3. Political crisis in emerging economies as a result of countries’ inability to control the coronavirus pandemic.

Fourth is the mounting tension between the US and China over Taiwan, a self-governing island that Beijing sees as part of its territory. The institute does not expect a “military showdown” over Taiwan this year, but said the tensions pose a “significant medium and long-term risk”.

Market forecasts

Growing technical rivalry between the US and China means that both governments will invest more in the industry, which makes it “important to invest in these two poles of global growth,” said BlackRock analysts.

In a separate report, they set out their expectations for market reactions to other geopolitical risks.

For example, the BlackRock Investment Institute expects the Chinese yuan to weaken as the split between US and Chinese tech companies accelerates. Analysts expect the US dollar to strengthen and US utility stocks to fall in a major cyberattack and Latin American consumer staples stocks to rise in an emerging market political crisis.

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Global stock indices have risen this year as major economies seek to raise vaccination rates and get back to business. The CBOE Volatility Index, or the VIX, a measure of fear in the US market, has fallen about 19% so far this year.

In the short term, BlackRock said it was justified for markets to focus more on the economic recovery from the coronavirus pandemic and the outlook for inflation.

However, they cautioned that “geopolitical risk breakouts could have an overwhelming impact when markets least expect it”.

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