Given the escalating geopolitical tensions and rising economic policy uncertainties, Citi Research has updated its Geoeconomic Risk Premium (GRP) model to provide strategic guidance for investors.
Citi's proprietary GRP model, which measures the discount rate applied to global equities due to geopolitical and economic risks, has recently shown a significant increase.
“Geopolitical risks are back in focus amid escalating tensions in the Middle East and Ukraine, as well as via the upcoming US presidential election and a potential US economic slowdown,” said analysts at Citi Research.
Although the Global Geopolitical Risk Index has recently decreased, the Economic Policy Uncertainty Index, particularly in Europe, has been on the rise. This suggests increasing concerns about economic stability, driven by potential US economic slowdowns and electoral uncertainties.
Historically, such conditions have contributed to heightened economic uncertainty, which can negatively impact equity valuations.
Citi’s analysis shows that defensive sectors are particularly resilient during periods of increased geo-economic risks. Sectors such as Health Care and Consumer Staples are better positioned to endure both economic and geopolitical uncertainties.
Utilities also stand out as a strong hedge against geopolitical risks. Conversely, cyclical sectors like Financials and Real Estate tend to be more negatively affected during these periods.
The sensitivity to geo-economic risks differs across countries. Switzerland stands out as a safe haven, demonstrating resilience to both economic uncertainty and geopolitical risks.
In contrast, Spain and Italy are more susceptible to economic uncertainties, while Germany and France face greater exposure to geopolitical risks.
The UK presents a more nuanced profile, with negative exposure to economic uncertainties but benefiting from geopolitical risks due to its energy sector.
Company size also plays a crucial role in navigating geo-economic turbulence. Large-cap stocks generally outperform mid and small caps during periods of stress.
Their stability and diversified revenue streams provide a buffer against the volatility that smaller firms may experience.
To mitigate the impact of rising geo-economic risks, investors may consider several strategic adjustments. Allocating a larger portion of their portfolios to defensive sectors like Health Care, Consumer Staples, and Utilities can offer stability during uncertain times.
These sectors have historically demonstrated resilience in economic downturns and geopolitical tensions.
Diversifying investments into countries that are less exposed to geo-economic risks can also enhance portfolio stability. Switzerland and Japan, for example, offer robust financial systems and political stability, making them attractive options for risk management.
Increasing exposure to large-cap equities can further protect the portfolio. Large-cap stocks tend to offer better protection against geo-economic shocks due to their financial strength and diversified operations.
Monitoring key economic and geopolitical indicators is essential. The Economic Policy Uncertainty Index and the Global Geopolitical Risk Index offer valuable insights into increasing risks, enabling timely adjustments to portfolio positioning.
While the Energy sector can benefit from geopolitical risks, its performance during periods of economic uncertainty can be less favorable. Balancing investments in Energy with allocations to other defensive sectors can help manage overall portfolio risk.