Geopolitical events and global markets impact the prices and returns of many asset classes. Whether it is the Chinese Yuan, the US dollar or gold, the markets can respond negatively or positively depending on the impact of the geopolitical event.
Whether green markets respond negatively or positively
If you’re an investor in the green bond market, you may be wondering whether or not it is the right time to invest in it. Green markets are gaining traction but the data is sparse and there are a lot of unanswered questions. Aside from the obvious question of if it’s a good idea, what’s the appropriate risk profile and the right taxonomy to follow, how can investors take advantage of it and when is the right time to do so? This study examines the impact of geopolitical risk on the green market. Specifically, we investigate whether there is a statistically significant correlation between geopolitical risks and performance in the green bond market. We also test whether geopolitical risk is more of an asset return or price shock to the green bond market. In addition to the traditional factors of demand and supply, geopolitical risk also relates to economics and politics. The impact of geopolitical risk on the performance of green bonds is not restricted to the United States and China. It is also possible for green investments to be exposed to risk from elsewhere in the world, such as Brazil or India.
The most common form of geopolitical risk is terrorism. However, the effects of terrorism are often muted, or at best, mitigated. Other forms of geopolitical risk include natural disasters, wars, and the like. Depending on the type of geopolitical threat, there are various ways in which these can affect the green bond market. For example, terrorism has been shown to negatively affect the value of assets, such as stocks. Likewise, wars can sabotage financial markets and damage the economy. In such circumstances, green investments should be on the watch list. On the other hand, high oil prices can increase the amount of green investments if companies are able to substitute oil with cleaner energy sources.
Although there aren’t a lot of empirical studies on this topic, there are plenty of other factors that could influence performance of green securities. Aside from the usual suspects (supply and demand), you can consider the effects of the geopolitical threat of a nuclear attack, a war in Syria, or a terrorist bombing of a high-profile target. Moreover, you can look into the effect of geopolitical risk on the green bond market by implementing a time horizon analysis. Ultimately, you’ll be able to identify which risk is the most important to your portfolio, if any. As a result, you should be able to make informed investment decisions when the time comes.
While the study has been limited by the aforementioned constraints, it nevertheless proves that the impact of geopolitical risk on green investments can be measured. As a result, you can make more informed decisions about how to best capitalize on this growing market.
Impacts on traditional asset prices and returns
The Russo-Ukrainian conflict has prompted several countries to reconsider their energy supply needs. This has led to an increase in economic uncertainty and increased prices of many commodities. There is also increasing interest in renewable energy. Several studies have examined the effects of war on the energy industry. They report positive and negative impacts on renewable and non-renewable energy. However, the relationship between the two has not been fully understood.
Geopolitical risk is a major determinant of financial decision-making. It can affect stock and bond prices, traditional assets, and even green investments. Although most research has focused on the effects of war on traditional energy, recent studies have shown that the impact of war on renewable energy is not necessarily negative. In fact, the Russo-Ukrainian conflicts have accelerated the deployment of renewable energy.
Studies have shown that the Russo-Ukrainian war caused a spike in the price of oil and other commodities. These increases have reinforced investor sentiments that higher energy costs could have a dampening effect on growth prospects. If the economic outlook becomes sluggish, there is potential for a sharp decline in equity returns. Likewise, increased energy costs will have an impact on borrowing costs and the resulting economic impact of projects.
Studies have shown that wars, terrorist acts, and other geopolitical events can adversely impact asset prices and company profitability. During periods of rising turmoil, investors should consider the findings of empirical studies when hedging their investments.
Some authors have argued that geopolitical risks can cause investors to seek alternative sources of investment. This could lead to increased volatility in the markets. But in reality, these effects on asset prices and return tend to be temporary. While a prolonged geopolitical shock might cause a plunge in the market, a short-term shock is more likely to have a positive effect.
There have been some studies that have examined the indirect effects of high oil prices on the equity and bond markets. Many investors seek out clean and green equity as a safer investment option. Moreover, investing in clean and green stocks and bonds helps to mitigate climate change. Since a growing percentage of the world’s energy comes from renewable sources, investors are able to take advantage of the opportunity to increase the sustainability of the economy.
Green equity is a safe haven during times of rising geopolitical turmoil. A study by Kuang et al. (2020) demonstrated that investing in clean and green equity is more appealing to investors than dirty energy markets. Similarly, a study by Gaied et al. (2017) revealed that the Russo-Ukrainian dispute created an opportunity to boost global climate change agreements. Additionally, the Russo-Ukrainian crisis resulted in a surge in public support for renewable energy policies in Europe.
In addition to the impacts on traditional assets, geopolitical risks can also have a major impact on the performance of emerging stocks and bonds. The conflict in Eastern Europe may reinforce investor appetites for growth stocks, value names, and other investment options.
Three key themes for fixed income investors
Fixed income investors face several key challenges, not seen in decades, that require a careful and disciplined approach to navigate the evolving marketplace. Among these are changes in the macro-environment, inflation, and global uncertainty. While the challenges are real, there are opportunities if investors are willing to explore them.
The United States economy has not yet entered a recession. Inflationary pressures remain on the rise, and the Federal Reserve remains steadfast in its effort to contain it. However, the path forward isn’t completely clear, as the Fed’s actions may inadvertently lead to a recession. As a result, many institutional investors are becoming less confident in their ability to meet future returns targets.
Rising inflation and a tighter financial environment have contributed to the worst performance in the Bloomberg Global Aggregate Index in more than two decades. Yields have also risen to their highest levels since the Global Financial Crisis. This has been accompanied by an inversion in the US Treasury yield curve. Although the inversion offers no clues on when the US will enter a recession, it has become a warning signal. Amid these rising rates, fixed income investors are challenged to meet their long-term investment goals in a low-yield environment. It is also important to avoid riskier high-yield bonds and focus on quality bonds.
One of the most interesting segments of fixed income to watch is emerging markets debt. Emerging markets have recently bounced back from a pandemic-induced slowdown, and the prospects for less aggressive monetary tightening should help them weather a higher global yield environment in the years ahead. Yet, there are a number of challenges associated with investing in emerging markets.
For one, emerging markets equities have evolved over the last two decades, providing investors with a continually changing portfolio of investment opportunities. In addition, demographic trends such as a growing middle class and more educated consumers have fueled faster adoption of new technology. Despite these trends, emerging markets equities have fallen victim to negative sentiment.
Geopolitical events and global markets are also important considerations for fixed income investors. Investors must closely monitor a variety of signals, including interest rates, inflation, and global uncertainty, and make informed decisions to protect their investments. Some of the most common sources of risk can be difficult to identify, and a multi-sector approach is often necessary. When faced with persistent volatility, it may be time to adopt a new strategy that emphasizes higher-conviction security selection and a broader array of investment opportunities.
The Fed’s recent moves to combat inflation have led to a more hawkish pivot from central banks, which has affected the asset allocations of many investors. With inflation expected to remain high in the coming months, the path forward for the US economy is not entirely clear. However, resilient labor market data suggests the US will avoid recession in the near term.