Demonstrators protest outside the Supreme Court on Dec. 8, 2016, the final day of a four-day hearing into whether Parliament’s consent is required before the Brexit process can begin.
For a second straight year, the biggest driver of world-wide stock prices may not come from the bottom line, but from the ballot box.
Geopolitical issues, particularly those related to the waves of populism seen throughout Europe, are viewed as a major risk for stocks in 2017, one whose likelihood or impact is difficult to measure. While bearish forecasts surrounding similar events last year failed to materialize, specific events—such as elections—are seen as possible turning points for the market.
The risks range from protectionist economic policies like tariffs or closed borders, seen as economic headwinds for the economy, to newly restrictive immigration policies that could also hamper growth by cutting off cheaper labor and revised regulatory approaches some believe could energize growth. Terror attacks or other forms of unrest could also contribute to volatility.
“Never before — not even during the global financial crisis — have investors come to us so concerned with such specific questions about the movements of the markets and governments around the world,” wrote Bill McNabb, chief executive officer of Vanguard, in a note to clients. “We’re living in unprecedented times.”
After the U.K. voted to leave the European Union last year, the country’s currency was pulled to multidecade lows. While the vote didn’t derail a rally in U.K. stocks, the situation remains uncertain, with analysts seeking clarity on what the actual structure of “Brexit” will look like. Over the weekend, U.K. Prime Minister Theresa May emphasized that “we are leaving” the bloc.
The economic fallout of the U.K. leaving remains unknown, but analyst expect it will result in fundamental shifts to both trade policies and immigration. The impact of either of these could be multiplied if other countries vie for similar exits or protectionist measures. Sigmar Gabriel, the deputy German chancellor, recently said that an EU breakup was no longer inconceivable.
In a recent note to clients, Citi cited a number of events throughout 2017 that could be market risks, starting in March, when the U.K. is expected to trigger “Article 50,” beginning the Brexit process. April and May will see the two rounds of France’s presidential election, where National Front leader Marine Le Pen has also advocated protectionist stances. Germany’s election will occur later in the year.
“If enacted, protectionist measures such as tariffs and quotas would damage trade and global growth,” wrote Steven Wieting, global chief investment strategist at Citi. “Tougher immigration controls risk creating labor shortages and making it harder for governments to collect enough taxes to support rapidly increasing retired populations. Lower growth and higher wage costs, meanwhile, represent an obvious threat to shareholder returns.”
The incoming administration of Donald Trump could also play into this. Trump’s victory sparked a Wall Street rally that took indexes to repeated records, and the president-elect has implied he could seek major changes to U.S. foreign policy with respect to Russia and NATO while threatening trade wars with China and Mexico.
Geopolitical issues contributed to investors dumping the biggest exchange-traded funds that track European equity markets last year. The Vanguard FTSE Europe ETF VGK, -0.35% saw outflows of $ 3.6 billion over the last year while $ 6.6 billion was pulled from the iShares MSCI Eurozone ETF EZU, -0.28% The SPDR EURO Stoxx 50 ETF FEZ, -0.06% had outflows of $ 1.5 billion.
There are signs that sentiment is improving. While European equity funds saw 38 straight weeks of outflows during 2016 — a record, according to Morgan Stanley data that goes back to 2000 — they turned positive on a monthly basis in December.
Charts displaying flows into and out of European equity funds, courtesy Morgan Stanley
Analysts also see opportunity in the region, specifically citing potential from the region’s banking sector — which particularly struggled in 2016 — and energy stocks.
“Right now geopolitical factors aren’t a major factor in our global assessments. It’s a fear more than anything tangible,” said Richard Weiss, a senior portfolio manager at American Century Investments, which has about $ 150 billion in assets under management.
But he also said those factors could have “significant ramifications for the global economy and financial markets.”
“Barriers to free trade are a clear and direct way to reduce overall economic growth on a global level,” said Weiss. “The spread of populist and nationalist movements overseas — and to some extent domestically — represent a significant financial and economic risk to the world and U.S. economy, and not just in 2017, but beyond.”