The Market’s Next Black Swan Is Climate Change

Bloomberg 19/07/2024

"Failing to do more to slow the planetary heating caused by greenhouse-gas emissions will gouge 40% from global stock valuations.

Fighting climate change is difficult partly because humans are weird. It’s difficult to get them to care about their own future well-being much less that of entire future generations. People blow retirement funds and skip leg day. You think they care about their imaginary great-grandkids?

But people do care about stock prices. Entire media empires and lucrative careers have been built out of talking about stock prices. Unlike the fuzzy details of unborn descendants’ lives, stock prices are concrete. Line go up, line go down. Simple.

So maybe this will get some attention: Climate change will be really, really bad for stock prices.

Failing to do more to slow the planetary heating caused by greenhouse-gas emissions will gouge 40% from global equity valuations, estimates a new study by the EDHEC-Risk Climate Impact Institute. Accounting for climate-change-accelerating “tipping points” such as Amazon-rainforest dieback or a Big Burp of gas from melting permafrost, the market losses rise to 50%. On the other hand, if the world gets its act together and limits warming to 2 degrees Celsius above preindustrial averages, then the hit to stock prices will be just 5% to 10%.

A key thing to note here is that these won’t be one-time losses, lead author Riccardo Rebonato, a finance professor at EDHEC Business School in London and former Pimco executive, warned in a webinar. There will be no reversion to the mean. More likely is a long journey through the wilderness like Japan’s Lost Decades.

“After Covid we had a massive GDP loss but then a rebound. Here it seems to be like a headwind, a continuous headwind, without a rebound,” Rebonato said. “It could be the Climate Lost Generation in equity returns.”

The EDHEC paper forecasts much bigger stock-market losses than most other studies do, Rebonato noted. That’s partly because those other studies focused on the costs of transitioning the global economy to renewable energy rather than the far greater havoc climate change will inflict on growth.

Rebonato’s study, which takes both transition and damage into account, is more consistent with the recent National Bureau of Economic Research paper estimating a 12% blow to global GDP for every 1C of warming. And the Potsdam Institute for Climate Impact Research recently warned a 19% drop in global incomes by 2050 is already baked in, even if we cut emissions aggressively starting today. It estimated $38 trillion in losses every year as a result of a chaotic climate.

Many researchers ignore climate damage on the theory that, because it’s far in the future, the market will heavily discount it. But the EDHEC study argues, convincingly, that investors will value money more and more as the economy weakens.

So in the early days of climate change, when economic growth is still relatively strong, investors won’t care as much about future losses. We’re rich anyway! Let’s buy a yacht! (See leg day, skipping, above.) But as the warming grinds on and the losses mount, those losses will become a lot more painful. Discounting will gradually be a thing of the past, like glaciers and snow.

And like objects in your rearview mirror, climate-change damage is already closer than it appears. Weather disasters cost the global economy $1.5 trillion in the 2010s, according to the World Meteorological Organization, up nearly tenfold from the 1970s after adjusting for inflation. The reinsurer Swiss Re has suggested insured losses from natural catastrophes will double in the next decade.

But such numbers drastically understate the potential effects of climate change on economic growth. As Rebonato notes, extreme heat, sea-level rise and other long-lasting impacts of global warming will do much more damage to human health and productivity than individual disasters like hurricanes or wildfires.

“Perhaps we are focusing too much on catastrophic events rather than on chronic damages,” Rebonato said. “There is a chronic aspect in terms of the loss of productivity, the loss of efficiency, which is less visible and more insidious and will create a continuous drag.”

Hence the Lost Generation.

The EDHEC study is another reminder that the $215 trillion (and rising) estimated price tag to avoid the worst global heating will eventually pale in comparison to the cost of not bothering. And as big and fuzzy as these estimates may seem, Rebonato considers them conservative. For one thing, his model assumes global central banks will always cut interest rates when economic growth is bad. As we all know, low interest rates make line go up. But pandemics, droughts and other global disruptions also raise inflation and public debt. That limits just how market-friendly central banks can be.

One other key finding of the EDHEC study is that these damage estimates aren’t close to being priced into markets yet. Many analysts have searched for a climate risk premium over the years and found only traces. To some extent, that makes sense: We can only guess at the damage at this point. And maybe markets optimistically assume we’ll avoid the worst. But we could also be like those people failing to save for retirement, sleepwalking toward a day when our failure to imagine the future leaves us with no future at all." 

Copyright Bloomberg 

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The Market’s Next Black Swan Is Climate Change