With one Sunday afternoon tweet, President Trump reintroduced what had recently vanished from financial markets: volatility. By Thursday May 9th, the VIX Index, which measures implied volatility on the S&P 500, had reached a four-month high. With a trade deal with China now in doubt, or at least less imminent, investors are reassessing their views on the economy and financial markets.
How much worse can things get?
To answer that, investors should focus on two factors, which are more quantifiable than the day-to-day news flow: expected growth and financial conditions. For now, the latter offers some comfort. While it is true that a complete collapse in trade negotiations would send stocks much lower and volatility much higher, easy financial conditions are one reason the recent pullback has not been more severe. Even at 23 the VIX is well below its December peak and less than half the level it reached in February 2018 (see Chart 1).
A few weeks back I discussed the interplay between financial conditions and the growth outlook. The key message was that financial conditions are central for assessing market volatility. This is even truer when growth is soft, as it is today. Fortunately, while growth is tepid financial conditions are considerably easier than they were late last year.
For example, high yield spreads remain about 25 basis points (bps, or 0.25% points) below the level from late March and 150 bps below the December peak. Long-term interest rates have also pulled back. At 2.45% U.S. 10-year yields are approximately 80 bps below the 2018 peak. Finally, while the dollar has strengthened a bit since, the Dollar Index (DXY) remains within its recent range. The bottom line: Outside of the stock market, most measures of financial conditions have eased. This is why most broad based measures of financial stress look much healthier than a few months ago.
Why is this important?
As I discussed back in April financial conditions ultimately explain the lion’s share of the variation in equity market volatility. In fact, a simple two-factor model, including high yield credit spreads and the St. Louis Financial Stress Indicator, has explained roughly 80% of the variation in the VIX during the past 17 years. What is it suggesting today? Assuming no change in financial conditions, volatility looks too high.
However, even in a post-QE world, financial conditions are not the only driver of markets; growth matters as well. The key risk is that the potential drag from tariffs is occurring at a time when economies outside of the United States are just starting to stabilize. Another disruptive period of trade friction represents a major risk for Europe and China. Should this occur, central banks may have little choice but to ease even more.
We expect euro-zone growth to pick up in the second half of this year. But the risks around our favorable base case are considerable – and they are mainly tied to potential political troubles.
The UK has bought more time to hammer out a Brexit agreement, but uncertainty remains. There may be renewed escalation of the trade tensions between the U.S. and EU, centered around car tariffs. U.S. President Donald Trump has until May 18 to decide whether to take action against European car producers on national security grounds. And European Parliament elections in late May could result in a populist sweep of protest parties from both ends of the political spectrum. This would further erode the influence of pro-European centrist political forces.
Heightened concerns about Europe’s future would likely lead to a renewed widening in peripheral euro-zone government bond spreads. See the Eyes on the wides chart. The 2020 budget season may refocus attention on the conflict between the Italian government and the European Commission. There are also going to be leadership changes this year in many EU Institutions, including at the ECB. The BlackRock Geopolitical Risk Indicator shows that investors are keeping a keen and wary eye on the risk of European fragmentation – it is the most prominent geopolitical concern for financial markets at the moment. It is not surprising that Europe is becoming increasingly under-owned.
Assessing the ECB’s options
We believe the ECB should pause further steps towards policy normalization for the remainder of this year – and likely beyond – to ensure a return of inflation to its below-but-close-to 2% price stability objective. At the upcoming meetings, the Governing Council will set the conditions for further long-term loans to banks (TLTRO3), discuss tiering of reserves and review its monetary stance. While a further extension of forward guidance would likely be the first line of defence, additional policy action is also becoming more likely. The continuation of ultra-accommodative ECB policy is reassuring for near-term growth. But the perceived lack of policy levers to counter any future downturn could rattle markets in the long term.
ECB President Mario Draghi could complete his eight-year term without once tightening policy. It is not clear whether his successor will get an opportunity to raise rates from -0.4% before the next downturn. If the next ECB policy move is to ease, there won’t be many options left in the monetary toolbox. In this situation, the ECB could either lift self-imposed constraints on its government bond purchases – the Public Sector Purchase Program (PSPP) – or move into new asset classes, such as equities or bank bonds, or push market interest rates even lower through rate cuts or forward guidance. Yet all of these options would likely face considerable opposition on the Governing Council.
Elga Bartsch, PhD, Head of Economic and Markets Research for the BlackRock Investment Institute, is a regular contributor to The Blog.
Market volatility is low until it isn’t, or so the saying goes. We’ve witnessed a volatility spike over the past week, as fading prospects for a U.S.-China trade pact shattered the calm after a prolonged period of low volatility in 2019. We are still cautiously pro-risk, but see the recent episode as a reminder of the potential for volatility to flare up – especially in the late phase of the economic cycle.
The market outlook had become more benign this year, following a selloff in the last quarter of 2018. Cross-asset implied volatility – a gauge of volatility across the equity, fixed income and foreign exchange markets – recently dropped to near record-low levels. See the chart above. Volatility in the currency markets had been particularly low, dragging down the average level across different markets. The backdrop behind low vol: a potential prolonged holding pattern by key central banks – most notably the Federal Reserve – coupled with a slowing but still growing global economy. Yet earlier last week market volatility spiked, after U.S. President Donald Trump’s tariff threat on China upended the expectation for an imminent trade agreement. The VIX Index, a gauge of the U.S. stock market volatility, jumped to the highest level since late January.
Reasons for caution
Last week’s market moves serve as a reminder that unusually low levels of market volatility likely do not accurately reflect the risks in this late-cycle period. Geopolitical risk is a key example. The market’s attention to global trade tensions – as reflected in chatter about the risk in analyst reports, traditional and social media – had dropped sharply from the peaks in mid-2018, our BlackRock geopolitical risk indicator (BGRI) shows. This was pointing to greater potential for market volatility should the risk flare up, as it has over the past week. We could still see a U.S.-China trade deal that includes a Chinese pledge to purchase more U.S. goods, among other items, yet implementation and enforcement will be challenging, in our view.
We still favor risk assets, given the ongoing global economic expansion and the prospect for central banks to stay accommodative. Yet macroeconomic volatility is increasing in this late-cycle period, reflected in the rising dispersion of analysts’ GDP forecasts. Our research suggests periods of rising macro volatility have historically featured greater market volatility. To be sure, we see major central banks on hold in the months ahead, providing a stable policy backdrop. But U.S. growth is slowing and economic data could become noisier in the months ahead after a sharp inventory buildup in the first quarter. Another potential source of volatility: In China, we see signs of a growth recovery, but the scale and longevity of the government’s stimulus package may soon be called into question.
Recent spikes in market volatility remind us a balanced approach is key to investing in the late-cycle period. We still see a narrow path ahead for risk assets to move higher – but there are risks that could knock markets off track. U.S. government bonds have historically played an important role in cushioning portfolios against such bouts of volatility. In equities, we favor the U.S. and emerging markets, with a focus on quality companies that can sustain earnings growth even in a slowing economy.
Scott Thiel is BlackRock’s chief fixed income strategist, and a member of the BlackRock Investment Institute. He is a regular contributor to The Blog.
“Sell in May and go away” is an old maxim for investors. Evidence is mixed on its validity, but given this year’s rally, the temptation now is understandable, particularly given the recent volatility driven by renewed trade conflicts with China. Our take: sure, consider taking some profits and rotating into exposures that offer more resilience if volatility returns. Think of it as the investor version of a “staycation” an opportunity to catch up on chores. But overall, we would not abandon equities.
With summer just around the corner, we highlight five major investor themes for the weeks ahead as discussed in our latest publication, the Summer Investment Directions:
1. In the U.S., consider reverting to technology.
We remain overweight U.S. equities, and one of our favored sectors is technology. Even with strong performance this year, we believe the sector remains appealing. Technology firms tend to have strong balance sheets and healthy earnings trends, as well as enjoying support from longer-term trends. These are all attractive qualities in a late economic cycle. Furthermore, tech stocks have historically fared well through various yield curve regimes.
2. Follow events in Europe, which may be poised for revival.
Investors in Europe have had little reason for optimism for some time. But we expect European growth to accelerate this year given solid domestic demand. Valuations look attractive relative to history, although political and trade risks linger. China’s efforts to stimulate its own growth could help export-heavy economies, such as Germany.
3. Keep an eye on reform progress in Brazil.
Brazilian assets have under-performed the broad emerging market index this year, despite signs that economic growth is accelerating and earnings prospects remain intact. Instead, investors are focused on the negotiations around pension reform. We expect volatility around the negotiations to continue until reform is enacted. Overall, we still favor emerging markets, however.
4. With the return of the benign regime, consider quality, intermediate-term fixed income spread assets.
The Federal Reserve’s rate hike pause has benefited fixed income sectors and assets across the board. Given the market expects rates to remain contained this year, these seemingly benign conditions could last for some time. In this environment, we favor quality, intermediate-term fixed income spread assets, such as agency MBS and high-grade corporates.
5. Relative strength leads us to upgrade the quality factor.
Our factor-tilting model examines multiple metrics including relative strength, which uses a simple measure of 12-month price momentum to determine the trending behavior of each factor and compare market sentiment in one factor versus the others. We’ve upgraded quality from neutral to overweight while downgrading minimum volatility and momentum.
By most metrics this has been a remarkable year for investors. Stocks are up more than 15%, their best start in decades. Nor is it just stocks. The risk-adjusted return (Sharpe Ratio) on a typical stock/bond portfolio is producing similarly spectacular results. But while the magnitude of year-to-date returns is clearly abnormal, in another sense 2019 resembles the post-crisis norm: U.S. equities are outperforming the rest-of-the-world (ROW).
As has been the case in previous years, the out-performance of U.S. stocks over most other markets is being driven by a mix of better earnings growth and relentless multiple expansion (see Chart 1). Since 2010, the S&P 500 Index has outperformed (on a price basis) the MSCI ACWI ex-U.S. Index by an average of 70 basis points (bps) a month, a statistically significant difference.
While investors have become accustomed to this state of affairs, it was not always the case. In the period between 1990 and the end of 2009, the return differential between U.S. and non-U.S. equities was much smaller. During that period the average monthly performance spread was 22 bps, the median, which is less influenced by extreme observation, an even more insignificant 8 bps.
All of this raises the question: Why have U.S. stocks been perennial out-performers since the financial crisis? There are many potential explanations, but one simple one is profitability.
During the “aughts” decade, the average spread in profitability, measured by the return-on equity (ROE) between the S&P 500 Index and the MSCI ACWI-ex-U.S. Index was roughly 1.5%. Not only was the spread relatively narrow, but those years witnessed a prolonged period, leading up to and including the financial crisis, when profitability was higher outside of the United States.
Things have changed post-crisis. Since the beginning of 2010 the average ROE spread between the two indexes has widened to 3.7%. Just as important, since the start of the decade, there has not been a single month when U.S. corporate profitability was below the ROW. Put differently, not only have U.S. companies been significantly more profitable than their non-U.S. counterparts, but excess U.S. profitability has been consistently more reliable in the post-crisis environment.
Faster growth the key
Why this should be the case is not hard to understand. U.S. growth, while below the pre-crisis norm, has been consistently faster than Europe and Japan, particularly when you compare nominal growth, i.e. the rate of growth before adjusting for inflation. Faster growth supports higher operating leverage.
The U.S. is also increasingly home to the world’s marquee companies in technology and communications, companies that tend to be consistently more profitable than the broader market. A quick example illustrates the point. The top three companies in the S&P 500 are Microsoft, Apple and Amazon. Their average ROE is 39%. By contrast, the top three companies in Europe–Total, SAP and LVMH–have an average ROE of 14%. Perhaps it’s not such a mystery why U.S. companies, despite materially higher valuations, continue to outperform.
Understanding how women think about investing is critical for the future of retirement. Women are on their way to holding the majority of wealth1, they stand to inherit 70% of the $1T intergenerational wealth transfer2, they’re the breadwinner (or co-breadwinner) in 60% of households3, they’re starting businesses at twice the rate of men4–the list goes on.
We wanted to find out–and the answer, it turns out, isn’t what you might expect.
Not so different
Survey findings that focus on gender differences often paint women as the underdog. Over the years, I’ve read lots of headlines that women save less than men, or that they’re afraid to take risk. But here’s the thing–most American workers have access to a 401(k) plan today, and these plans have evolved to automate things like contribution rates and default investment options for all employees. The effect has been that women and men, by and large, are saving at comparable rates and are invested at similar risk levels over the course of their careers.
In other words, we’re all in the same boat.
So, I think it’s time we let go of the old narrative. It’s not about women being behind the curve–and it’s certainly not about pitting women against men.
Spare me the jargon
When DC Pulse dug into some of the reasons why half of women don’t feel on track for retirement, many mentioned that they feel alienated by the financial industry. They told us they don’t relate to their employers’ communications; in fact, only 46% of women agreed that those materials help them decide how to manage their retirement savings.5
And that’s largely on us. There’s more we need to do as an industry, working in partnership with employers, to ensure the educational tools and resources we develop resonate with how people actually want to consume information.
Women are telling us that they want to be spoken to in more accessible ways. They want less jargon, to be taught not told, and a more practical focus.
We just need to connect the dots. Those of us in the investment industry need to speak more about life choices and practical outcomes. We need to draw the connection between planning today and the retirement income and lifestyle investors want for tomorrow.
And as individuals, if we are not getting the pragmatic communications we want, we need to ask for the tools and insights to help us relate our choices to our lives.
I think we’ll find that everyone will appreciate a new level of clarity.
Anne Ackerley is the Head of BlackRock’s U.S. & Canada Defined Contribution (USDC) Group and a regular contributor to The Blog.
U.S. stock indexes have rallied to new highs in recent weeks. The S&P 500 is up roughly 25% since its December low, fueled partly by encouraging first-quarter earnings results. What does this mean for our view of U.S. equities? We still favor them, as cost-cutting and efficiency gains help moderate the earnings slowdown.
U.S. corporate profit margins are holding up, despite rising concerns that today’s low unemployment rate could spur labor shortages — and wage inflation. Attention to these trends is reflected in our text-mining analysis of broker reports from 2004 to 2019. We found the share of reports that carry the phrase “margin pressure” is now below the historical average, even as the share of documents with the phrase “tight labor” is at all-time highs. See the chart above. How to explain this apparent disconnect? Companies have been using technology to drive efficiencies that keep costs down, reduce the need for labor and help keep profit margins stable. See the “automation” line in the chart, which reflects this trend. To be sure, the pressure on earnings is likely to intensify in this late-cycle period as wage inflation picks up and productivity growth slows. Yet for now, companies are taking actions to cushion the downside, with many also returning capital to shareholders through share buybacks.
A better (but not great) earnings picture
U.S. earnings growth has slowed sharply from the double-digit pace of 2018. First-quarter earnings are up just 2.3% from a year earlier based on the companies that have reported to date, representing 80% of the S&P 500 market capitalization. Ahead of this earnings season, consensus estimates were pointing to a modest year-on-year contraction, the worst quarter for S&P 500 earnings growth since the second quarter of 2016. Companies have been beating forecasts at a higher rate than previous quarters, as subdued analyst expectations had lowered the bar for U.S. earnings beats. Earnings also appear solid when viewed in the context of slowing global economic growth and the fading impacts of U.S. fiscal stimulus. Yet we are still seeing more downgrades to analyst earnings expectations than upgrades this quarter, even as the pace of downgrades has eased over the last four weeks. Any bottoming out of earnings expectations could support a market that has rallied aggressively this year.
Some of the biggest drags to results appear to be diminishing for cyclical and resource sectors. Consider the improving Chinese economy and incremental progress in U.S.-China trade talks. The latter, along with dovish Fed expectations, contributed to markets recently reaching record highs. Yet sentiment does not appear ebullient, and the ability of companies to generate decent earnings growth despite a slowing economy speaks to their ability to drive efficiencies. Meanwhile, China could be a further boon to earnings growth. We expect a turnaround in Chinese growth from the second quarter.
There are risks to our outlook.
Trade tensions could intensify again. And market expectations for Fed rate cuts are too dovish, in our view, meaning the Fed is less likely to provide additional support to equities. Not all sectors are created equal. Analysts expect expanding margins this year in the technology, health care and consumer discretionary sectors, while they see margins of defensive sectors more challenged. Finally, market punishments for misses have been more severe than in previous quarters, with low tolerance for poor results at this late-cycle stage. Yet here’s our bottom line: First-quarter earnings have confirmed a better earnings picture than expected, supporting our near-term preference for U.S. equities.
Kate Moore is BlackRock’s chief equity strategist, and a member of the BlackRock Investment Institute. She is a regular contributor to The Blog.
Europe is still holding back global growth, having been a key support in prior years. Yet much of the eurozone weakness can be attributed to the fading support from export demand as world trade nosedived. As the most open G3 economy, Europe suffered more greatly.
In the coming months, we expect Europe to gradually move out of its tricky spot, as we write in our Macro and market perspectives A renewed spring in Europe’s step. This view assumes that the UK’s dragged-out Brexit debate doesn’t morph into a disruptive exit and rising US-EU trade tensions don’t shock confidence.
The U.S. slapping tariffs on European products–whether autos or other–should have only a moderate direct economic impact. Unless it sparks a broader confidence shock, this shouldn’t disrupt the solid domestic economic picture. And so we expect the upbeat domestic trend to reassert itself once global trade starts to normalize and idiosyncratic setbacks–such as auto production–and sector bottlenecks fade.
Euro-zone growth is supported by accommodative monetary policy, a more expansionary fiscal policy stance, higher than normal capacity utilization rates and labor markets approaching full employment. Our financial conditions indicator (FCI) shows that euro-zone conditions have eased significantly in the first part of 2019 – an improvement that is on par with the one seen in early 2016. For that reason, we expect GDP growth to pick up and move slightly above trend levels (around 1.25%) in the second half of this year.
What underpins our call for a recovery?
A rebound in the FCI, Chinese stimulus and fading headwinds. Half of the nearly 80 euro-zone activity indicators, summarized in our euro-zone Growth GPS nowcast, are starting to show meaningful improvement.
Industrial data for the start of the year are still poor. Germany–where factory orders plunged in February–remains the weakest link. But other data–especially for the services sector–are holding up or starting to recover. And incoming information on near-term growth tentatively suggests building momentum at the start of the second quarter. Our euro-zone Growth GPS started to stabilize in mid-March, indicating that the consensus forecasts for euro-zone GDP over the next 12 months are close to bottoming out. See the Reading the recovery chart.
The GDP forecast downgrades that began at the start of 2018 may have nearly run their course. Historically, our GPS signal has led consensus forecasts by about three months (see our interactive macro dashboard for more detail). This suggests that investors still have some time to position themselves for potential forecast upgrades.
Elga Bartsch, PhD, Head of Economic and Markets Research for the BlackRock Investment Institute, is a regular contributor to The Blog.
Cyclicals rule. After getting trounced in Q4, year-to-date more cyclically oriented stocks and sectors have trounced “defensive”, less-cyclically exposed names. The trend has been even more pronounced during the past month. For example, in April financials have outperformed healthcare by 1200 basis points (bps, or 12% points)!
While healthcare’s under-performance has been in large part driven by growing concerns that, depending on the outcome of the 2020 election, U.S. healthcare policy could undergo a seismic shift, divergent sector performance has not been confined to financials and healthcare. Month-to-date the technology and consumer discretionary sectors are both up more than 4%, while utilities stocks are down on the month and consumer staple names are up just about 1%.
Can this continue?
Two factors suggest that it can, although probably at a slower pace: defensive sectors are still not that cheap and economic expectations may already reflect enough pessimism.
Starting with valuations, both the S&P 500 utilities and consumer staples sectors are currently trading at a 2-3% premium to the broader market. Although the premium may be justified for staples, as these companies tend to have structurally higher profitability, it looks out of place for the slower growing utility sector. Since the financial crisis U.S. utility stocks have tended to trade at about a 10% discount to the market.
Another way to look at relative value is versus interest rates. Since the financial crisis both sectors have often traded more in line with interest rates than the equity market. This is because many investors think of them as “bond market proxies,” i.e. less volatile stocks you own primarily for the dividend. After taking into account the recent backup in rates, both sectors look too expensive relative to the broader market.
To be fair, both sectors have been more expensive and could probably support premium valuations if economic expectations continue to fall. The challenge for defensive names is it looks like expectations may have already fallen too much.
Some interesting work by my colleague Kevin Bynum illustrates the point. Looking at previous periods when economic surprises became unusually negative, defined here as periods when the Citi U.S. Economic Surprise Index dipped below -50, these periods tend not to last very long (see Chart 1). This suggests that the recent drop in the U.S. Economic Surprise Index may be fleeting, particularly given the recent easing in financial conditions.
Should the U.S. Surprise Index start to recover from its recent low of -67, this may support further cyclical out-performance. Historically, once the Surprise Index climbed back above -50, cyclical sectors outperformed defensive ones by an average of about 5% during the following six months.
After strong relative performance in Q4, it is not obvious that defensive stocks are particularly cheap. At the same time, assuming any stabilization in growth, particularly relative to expectations, cyclicals can continue to run.
Investing involves risks, including possible loss of principal.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of April 2019 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.
Increasing average global temperatures are boosting the frequency at which extreme weather events occur, as well as their intensity. These events, including hurricanes and coastal flooding, pose risks to portfolios that have been hard to pinpoint–until now. Our recent publication Getting physical showcases our new capability to analyze climate-related risks in portfolios down to the exact geographical location and asset level.
We draw on cutting-edge physical climate models from Rhodium Group as well as our own asset-level analysis to assess the risks to municipal bonds, commercial mortgage backed securities (CMBS) and utility stocks on a localized level across the United States. We shared some of our conclusions in the recent post What do climate risks mean to your portfolios? Looking for more? The four charts below nicely depict our findings, showing the potential impact from climate-related risks on these three markets.
Chart 1: Mapping the Damage
The Mapping the Damage graphic below illustrates how we can now gauge the likely overall economic impact of climate-related risks on a localized basis. The heat map visualizes the expected changes to gross domestic product (GDP) across the U.S. under a “no climate action” scenario, assuming ongoing use of fossil fuels. We find some 58% of U.S. metro areas will likely suffer annualized GDP losses of 1% or more by 2060-2080.
The biggest likely losers: the Gulf Coast region, the South Atlantic seaboard and much of Arizona. See the orange tones in the map. Florida tops the danger zones, with Naples, Panama City and Key West seeing likely annual GDP losses of up to 15% or more, mostly driven by coastal storms. Note these are average annual estimates; losses would likely come in big weather-driven shocks that could be much larger for a given year. The losses are not baked in: Decisive action could mitigate them. Yet the vulnerabilities revealed in this analysis have important implications for municipal bond issuers and investors. Our analysis shows climate-related risks pose a threat to the economies–and creditworthiness–of many U.S. state and local issuers in the $3.8 trillion U.S. municipal bond market.
Chart 2: A growing burden
Based on our work translating physical climate risks into implications for local GDP, we find a rising share of muni bond issuance over time will likely come from regions facing economic losses from rising average temperatures and related events. Within a decade, more than 15% of the current S&P National Municipal Bond Index by market value could come from U.S. metropolitan statistical areas suffering likely average annualized economic losses from climate change of up to 0.5% to 1% of GDP. And the impacts are projected to grow more severe in the decades ahead. This is illustrated in the A growing burden chart below.
icon-pointer.svg Read more on climate-related risks in our Getting physical publication.
Chart 3: Stormy weather
The Stormy weather chart below shows how the economic impacts of a warming climate could lead to rising U.S. CMBS loan loss rates over time. We illustrate the increasing risk to the U.S. CMBS market by overlaying Rhodium’s hurricane modeling onto the roughly 60,000 underlying commercial properties in BlackRock’s CMBS database. Our findings: The median risk of one of these properties being hit by a Category 4 or 5 hurricane has risen by 137% since 1980. Within three decades, the chance of being hit by a Category 5 hurricane is estimated to rise 275% under a “no climate action” scenario. See the chart below.
Chart 4: How exposed is my power plant?
Aging infrastructure leaves the U.S. electric utility sector vulnerable to climate shocks such as hurricanes and wildfires. We assess the exposure to climate risk of 269 publicly listed U.S. utilities based on the physical location of their plants, property and equipment. Our climate risk exposure scores by power plant combine the exposure to extreme weather at each power plant location with an assessment of the materiality of that exposure, based on historical losses and forward-looking climate modeling. See the How exposed is my power plant? chart below for a geographic representation of our climate risk scores by power plant. We then aggregate the average physical risk across all power plants to arrive at a total climate risk score for each utility.
A key finding from our analysis: Extreme weather events are not priced into the equities of U.S. electrical utilities. We find those with exposure to extreme weather events typically suffer temporary price and volatility shocks in the wake of natural disasters. We also find some evidence that the most climate-resilient utilities trade at a premium. We believe this premium could increase over time as the risks compound and investors pay greater attention to the dangers.
The work featured above and in our new paper is just a first step, focusing on three sectors with long-dated assets that can be located with precision. We plan to extend the research to other global regions, asset classes and sectors over time as data availability improves. Yet our early work already strengthens our conviction that sustainable investing is increasingly a “why not?” proposition.
Brian Deese is Global Head of Sustainable Investing at BlackRock and a contributor to The Blog.