Daily Update: May 10, 2024

Start every business day with our analyses of the most pressing developments affecting markets today, alongside a curated selection of our latest and most important insights on the global economy.

The Point of No Return

Systems tend to vary around their own average value. If you look at a given set of numbers — for example, the returns on a hedge fund — you will see that they tend to revert to the mean of market-level returns over time. This predictable variance is useful in various financial applications, including modeling risk. However, there are times when a system reaches a tipping point — when it has undergone so much change that the old predictive models no longer apply and old averages mean little. The system may eventually reach a new point of equilibrium, but for a time, predictive models based on old data have minimal value.

S&P Global Ratings Chief Economist Paul Gruenwald examined the basic mechanics of tipping points in “A Primer On Tipping Points.” Tipping points have been top of mind for many market participants because of anthropogenic climate change and the energy transition. Climate change and the transition to low-carbon energy sources are situations where an established order, such as average global temperatures or the global energy mix, undergo slow change before accelerating rapidly.

According to Gruenwald, a tipping point is a critical threshold in a dynamic system. Gruenwald uses the example of a depleted biosphere, such as a rainforest, which is capable of self-repair. However, if environmental damage is prolonged or too great, it reaches a point of no return and can no longer function as a rainforest. 

The critical feature of tipping points is that there can be a huge variance in outcomes depending on the trend of the data entering the tipping point. For example, there are average global temperatures that can trigger a massive release of methane from oceans or permafrost. Exceeding these temperatures yields a starkly different climate outcome, even if only by 0.5 degree C.

From Gruenwald’s perspective, tipping points become a matter of economic importance because economies become critically dependent on environments. The economy and environment can recover from damage to a point, but they will become unpredictable if pushed too far.

Today is Friday, May 10, 2024, and here is today’s essential intelligence.

- Written by Nathan Hunt.

Read all of our research and insights here.