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In light of rising geopolitical tensions and increasing uncertainty about economic policy, Citi Research has updated its Geo-Economic Risk Premium (GRP) model to provide strategic guidance to investors.
Citi’s GRP model, which measures the discount rate applied to global equities due to geopolitical and economic risks, has shown a significant increase recently.
“Geopolitical risks have returned to focus amid rising tensions in the Middle East and Ukraine, as well as the upcoming US presidential election and a potential economic slowdown in the US,” analysts at Citi Research said.
Although the global geopolitical risk index has recently declined, the economic policy uncertainty index, particularly in Europe, has been rising. This indicates growing concerns about economic stability, driven by a potential slowdown in the US economy and electoral uncertainty.
Historically, such conditions have contributed to increased economic uncertainty, which can negatively impact stock valuations.
Citi analysis shows that defensive sectors are particularly resilient during periods of increased geoeconomic risk. Sectors such as healthcare and consumer staples are better positioned to withstand economic and geopolitical uncertainty.
Utilities also stand out as a powerful hedge against geopolitical risk. Conversely, cyclical sectors such as financials and real estate tend to be more negatively impacted during these periods.
Countries’ sensitivity to geoeconomic risks varies from country to country. Switzerland stands out as a safe haven, having demonstrated resilience in the face of both economic uncertainty and geopolitical risks.
In contrast, Spain and Italy are more exposed to economic uncertainty, while Germany and France face greater exposure to geopolitical risks.
The UK has a more nuanced picture, with negative exposure to economic uncertainty but benefiting from geopolitical risk due to its energy sector.
Company size also plays a crucial role in dealing with geo-economic turmoil. Large-cap stocks typically outperform mid-cap and small-cap stocks during stressful periods.
Its stability and diversified revenue streams provide protection against the volatility that small businesses may face.
To mitigate the impact of rising geoeconomic risks, investors may consider making several strategic adjustments. Allocating a larger share of their portfolios to defensive sectors such as healthcare, consumer staples, and utilities would provide them with stability during uncertain times.
These sectors have historically proven their resilience in the face of economic crises and geopolitical tensions.
Diversifying investments into countries with less geo-economic exposure can also enhance the stability of an investment portfolio. For example, Switzerland and Japan offer strong financial systems and political stability, making them attractive options for managing risk.
Increasing exposure to large-cap stocks may provide greater protection to a portfolio. Large-cap stocks tend to provide better protection against geoeconomic shocks due to their financial strength and diversification.
Monitoring key economic and geopolitical indicators is essential. The Economic Policy Uncertainty Index and the Global Geopolitical Risk Index provide valuable insights into emerging risks, enabling timely adjustments to portfolio positioning.
Although the energy sector may benefit from geopolitical risk, its performance during periods of economic uncertainty may be less favorable. Balancing energy investments with allocations to other defensive sectors can help manage overall portfolio risk.
