How climate change may impact financial markets
How climate change may impact financial markets
What are these forecasts?
Each year Schroders’ economics and multi-asset teams join forces to produce 30-year return forecasts for a range of asset classes around the world. Until now, these forecasts have been agnostic on the subject of climate change; there have been no adjustments for the costs associated with global warming.
Can you explain briefly how you calculated the economic impact of climate change?
We used three steps. The first step is a focus on what happens to economic output as temperatures rise, which we will refer to as the ‘physical cost’ of climate change. The second considers the economic impact of steps taken to mitigate those temperature increases. This is the ‘transition cost’. Finally, we adjust for the effects of “stranded” assets. This is where we take account of the losses incurred where oil and other carbon-based forms of energy have to be written off, as it is no longer possible to make use of them, such that they are left in the ground
Why have you only just introduced the impact of climate change into your process?
The quantity and quality of academic research on the economic effects of climate change has increased markedly. As an example, economists Marshall Burke and Vincent Tanutama published a paper in 2019 that looked into the relationship between rising temperatures and economic output, using an extremely granular data-set on both temperature and output growth. We were able to feed their findings, and the research of other economists, into our return predictions.
What were their findings, broadly speaking?
Burke and Tanutama found that rising temperatures are more harmful to economic productivity in countries that are already warmer. The effect was found to be similar in rich and poor countries, suggesting that economic development does not yield much protection against climate change. However, they noted that poorer countries are generally starting from a higher base temperature and so face greater economic losses from climate change.
Why does temperature affect economic output?
The optimal average temperature for an economy is said to be 10 to 12 degrees Celsius. Much warmer or colder and it just becomes harder for people to do things. With temperatures much above 35 degrees, for example, the human body simply cannot function for long. High or low temperatures also negatively impact crop yields. They also add to the cost of production through heating or air conditioning costs.
Low temperatures can also bring infrastructure to a standstill, as we see in the UK virtually every time it snows. Some countries such as Canada and Russia, for example, are actually benefiting already from a warmer world as the Arctic becomes more navigable.
How does it affect the 30-year return forecasts?
As goes economic productivity, so go our return forecasts. Warmer countries lose out in a warming world, while colder countries see increased returns.
Which countries are worst affected?
There are reductions in expected returns for hotter countries. India is the worst affected, feeling both the productivity hit of rising temperatures and the large potential cost of carbon pricing.
Over the next 30 years, inflation-adjusted returns from India’s stock market are forecast to be 6.2% per annum without climate change. With climate change, returns are forecast to be 2.3% per annum.
Among the other worst hit markets are Singapore and Australia.
Which stock markets might benefit?
For investors in Switzerland, Canada and the UK, climate change may actually boost returns from their domestic stock markets, according to our forecasts.
Annualised inflation-adjusted returns from the Swiss stock market over the next 30 years would be 4.1% without any climate change, but 5.4% with climate change. In Canada, the respective numbers are 4.4% and 5.4%, while in the UK they are 5.7% and 6.0%.
Does this mean these countries should do nothing about climate change?
Most certainly not. Although this paints a positive picture in these countries for the next 30 years, the longer term picture is of further increases in temperature and more widespread economic losses. The analysis also focuses on economic impact and market returns, not the many other negative side effects of global warming. This is in no way an endorsement of standing still on climate change.
How are bonds affected?
The stock market story is mirrored in the bond market, with Canadian and UK government bonds the main beneficiaries. UK corporate bonds and inflation linked bonds are also significantly upgraded as a result. Singapore, Australian and Asian government bonds are particularly negatively affected.
The full research is available below.
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