Geopolitical flare-up may “catch investors off guard”, warns BlackRock

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Markets are paying less attention to geopolitical risks as focus has shifted to inflation prospects and economic restarts, according to BlackRock Investment Institute.

The research arm of the world’s largest asset manager said in a note on Monday that its Geopolitical Risk Indicator is currently at a four-year low, signalling below-average attention on geopolitics.

“We believe this is justified, as investors appear more focused on the economic restart and inflation outlook and less concerned about geopolitics since the change in US administration,” write BlackRock’s analysts.

“Yet it’s worth watching specific risks as flare-ups can catch investors off guard when attention is low.”

Risks including US-China strategic competition, Covid-19 resurgence and Gulf tensions have receded in the minds of investors over the past year, write the analysts.

BlackRock’s Geopolitical Risk Indicator ranks the top 10 geopolitical risks, based on mentions of different geopolitical risks in brokerage reports and financial news stories, coupled with the firm’s model for the potential impact on global assets from specific geopolitical events.

Two of these risks, a global technology decoupling and a major cyber-attack, remain ‘high’, according to BlackRock.

“We see a high likelihood that decoupling of the US and Chinese tech sectors accelerates in scale and scope, despite the relatively low attention to the global technology decoupling risk. The pace of global reshoring of technological supply chains has sped up, potentially increasing production costs,” the BlackRock analysts say.

The Biden administration has continued Trump’s “posture of intense rivalry” with China, they add, also noting that the Chinese government prioritised tech self-reliance in its latest five-year plan.

BlackRock says it will be key to invest in “both these poles of global growth”.

When it comes to the risk of a major cyber-attack, the analysts point to a “disconnect” between market attention and fundamental analysis.

“Attention to major cyber-attack(s) risk has receded from a 2020 peak, yet we see a high likelihood of this risk occurring,” write the analysts.

They note a recent ransomware cyberattack on the Colonial Pipeline that shut down the main network supplying fuel to the East Coast of the US in May. This led to a rise in oil prices, and shares in US energy firms went up by 1.5 per cent.

Elsewhere, BlackRock has written that attacks on critical infrastructure are “increasing in scope, scale and sophistication”.

“Repeated attacks present the possibility of significant damage and sustained disruption. This could spill over to both financial markets and the real economy," says the asset manager.

Also underplayed in financial markets is the risk of a conflict with North Korea, says BlackRock.

The analysts write: “Market attention to a potential North Korea conflict is well below the historical average, but we rate the likelihood of the risk as “medium” – and see tensions as likely to increase heading into 2022.”

Concern over North Korea’s nuclear programme has been growing since the country fired two rounds of short-range ballistic missiles into the Sea of Japan in March.

They note that North Korean provocations, including long-range missile tests and potential for a nuclear test, “could trigger a possible escalation”.

In the near-term, BlackRock says that the decreasing market attention on geopolitical risks as a whole are justified because of powerful near-term market drivers such as the economic restart and inflation outlook.

“We remain pro-risk, but note that geopolitical risk flare-ups could have an outsize impact when markets least expect it,” write the analysts.