While all eyes in the U.S. are on the new administration and the anticipated shifts over the coming year in fiscal policy, the real action for capital markets in the coming year may come from abroad. The world is not without its risks and instabilities as 2017 gets underway. Here are five global hot spots that will be worth watching for potential sources of volatility in the months ahead.
Remember the Brexit vote from late June 2016? It seems like such a long time ago now with all that has taken place in the months since. And while the outcome of the vote was largely dismissed by a wide swath investors given its minimal impact on financial markets at the time, the reality remains that nothing associated with Brexit other than a vote and a subsequent change in leadership in the United Kingdom has actually happened yet.
In the months ahead, the United Kingdom will formally announce its intention to depart from the European Union. This process is currently scheduled to begin in March, but it may be delayed until later in the year depending on whether it is determined that parliamentary approval is needed. It is here where the effects of the Brexit vote will start to be felt by financial markets. For while much uncertainty remains as to exactly how this process will all play out, speculation surrounding the various different ways things will play out will begin to give way to the reality of it actually happening. Its associated economic and market effects will soon follow and their implications remain to be seen. But if nothing else, the persistent weakness of the British Pound (NYSEARCA:FXB) relative to both the U.S. dollar (NYSEARCA:UUP) and the euro (NYSEARCA:FXE) suggest that the adjustment process may not necessarily be seamless for the world's fifth largest economy.
While any associated struggles with the Brexit transition is not necessarily a deal breaker for the global economy and its markets, it does have the potential to cause dislocating tremors along the way, particularly for those with more direct currency unhedged exposure to U.K. markets (NYSEARCA:EWU).
Instead, arguably the greater longer-term risk for the global financial system is the transition for the U.K. out of the European Union (BATS:EZU) to go far more smoothly than expected. For if the transition is relatively seamless and the United Kingdom economy starts showing signs down the road of thriving under its new freer circumstances, it will only encourage its many frustrated European (NYSEARCA:IEV) neighbors that are frustrated with the common market and its various rules and restrictions to make their own way to the exits.
Speaking of European Union members that could potentially be increasingly agitating for ditching the EU and its euro currency, Italy (NYSEARCA:EWI) is another global hot spot to watch in 2017. In another vote that the U.S. stock market (NYSEARCA:SPY) twisted into a reason to celebrate, the Italians' "no" vote in December for a constitutional referendum that would have enabled fiscal policy in the country to be carried out more efficiently and effectively has put the outlook for the world's eighth largest economy and third largest debt market in doubt.
We have already seen the departure of Matteo Renzi as prime minister in the wake of the "no" vote, which has raised the potential for fresh elections in the year ahead. With the upstart and Eurosceptic Five Star Movement now even with the incumbent Democratic Party in the latest general election polls, it is very possible that we could see new leadership for the third largest economy in the Eurozone that is against the common market experiment.
But even before the constitutional referendum, the country's banking system was already coming under increasing strain with at-risk institutions such as Monte dei Paschi di Siena teetering on the brink of insolvency, and these new challenges associated with political uncertainty are only likely to compound the problem. Such concerns are likely being reflected at least in part in the continued weakness of the euro currency, which is testing new lows relative to the U.S. dollar despite the fact that the European Central Bank has shifted toward winding down its own extraordinary stimulus program in recent months.
Does the collapse of a group of Italian banks, if it were to get to this point, imply negative consequences for global financial markets? Not necessarily, as it would depend on how well the problem was contained. Whether such an outcome may be imminent and has the potential to result in spillover contagion effects can be tracked by monitoring the stock price performance of European financials (NASDAQ:EUFN) in general and shares of Deutsche Bank (NYSE:DB) in particular. And in both cases, they seem much more reassured today than they did last July and September, respectively.
Of course, when it comes to banking system stress, things can turn on a dime quickly, so the challenges coming out of Italy are worth keeping on the radar screen.
Turkey (NYSEARCA:TUR) is a country of geopolitical importance not only for its sheer size and geographic location between Europe and the Middle East but also its importance as the 18th largest economy in the world. The economy has been coming under increasing pressure from the strengthening U.S. dollar and rising U.S. interest rates given its current account deficit and volume of U.S. dollar denominated debt. At the same time, the primary drivers of its economy are being undercut by recent developments in the country. The recent political instability including the failed coup attempt and the move to concentrate power under President Erdogan that has included the tightening of political controls over the economy has caused jitters in the flow of foreign business investment into the country. At the same time, these uncertainties coupled with a growing series of terrorist incidents has undercut tourism activity in the country.
All of these forces have put Turkey on an increasingly deteriorating path from an economic and market perspective.
The global economy and its markets have certainly shown the mettle to withstand challenges associated with individual economies in the developed and emerging world. And it is unlikely that investors will view any challenges specific to Turkey as circumstances that would spread with any contagion style spillover effects the way they might have in the past. But given its size and its importance in the global geopolitical landscape not to mention its status as an economy with a sizeable current account deficit and U.S. dollar denominated debt, Turkey is still a hot spot worth watching in 2017.
India (NYSEARCA:EPI) is a country that continues to grow in importance for the global landscape. It is already the world's seventh largest economy and could leap ahead to the fifth spot in the next few years. According to the United Nations, it is also on the brink of surpassing China as the country with the world's largest population as soon as the coming year when the latest data is reported. In short, India (NYSEARCA:PIN) is a big player in the global economy despite its continued status as an emerging market (NYSEARCA:EEM), which alone makes it worth watching in any given year.
The Indian economy has been suffering through a bumpy patch in recent months. The country has garnered investor excitement in recent years after pro-growth and reform-minded Prime Minister Modi came into leadership with the first parliamentary majority in decades. At the same time, its current account deficits and U.S. dollar denominated debts have raised investor concerns along the way. But it was the recent government-mandated demonetization program that has rattled the economy and investor nerves in recent months.
The program that was designed to undercut the underground economy has caused disruptions in regular business activity. And it is now questionable whether the program had any measurable impact in changing the problems it was meant to address. While any negative political consequences associated with the program are likely to fade over time, it will be worth watching to see what effect if it has, if any, on further economic reform efforts in the coming months.
As for the investment portfolio impacts, it remains important as the second to fourth largest allocation in most broad emerging market stock indices. Moreover, it, like Turkey, remains an important signal as to the realization of potential negative spillover effects from the strong dollar and rising interest rates on global markets.
China (NYSEARCA:GXC), more than any other country, is a global hot spot worth watching in 2017. Not only is it significant given its status as the second largest economy in the world, but China (NYSEARCA:FXI) is full of economic and market instability kindling that could ignite at the expense of global financial markets including the U.S. at any given point in time.
The country is already filled with massive economic distortions such as its ghost cities built to house tens of millions of residents are barely occupied. But in recent years, it has also undertaken the tricky challenge of working to transition its economy from export supported to more domestic consumption driven. This has been a process that has come with its measurable growing pains such as the inflation of a massive stock market bubble in 2015 that was just as quickly deflated. At the same time, the economy has been coping with various challenges including debt levels that are soaring to historically dangerous heights, a torrent of capital outflows outflow rushing out of the economy in recent months and still large but increasingly dwindling foreign exchange reserves.
As evidenced by the wild swings in the yuan currency over the last few days to start 2017, it is likely that these policy adjustments and their associated global market implications will almost certainly continue in the coming year with still unforeseen consequences.
The implications for investment portfolios including those that are based in the U.S.? Absolutely enormous.
I will put it this way. As we head out into 2017, I will likely be spending more time from a macroeconomic perspective monitoring events taking place in the China economy more than anything else by far. For events over the past couple of years have repeatedly demonstrated that when extraordinary events are taking place either to the upside or downside in U.S. financial markets including stocks, bonds (NYSEARCA:BND), commodities (NYSEARCA:DJP-OLD), and gold (NYSEARCA:GLD) that seem to be beyond any reasonable explanation and that the financial media is trying to attribute to something that may or may not happen six to nine months from now, more often than not the reason can be traced to events that are taking place in China at that very moment.
As a result, given the interest of investors to try to stay ahead of market movements as they unfold, keeping a close watch on the hottest of global hot spots in China should be a most worthwhile exercise in the coming year.
The events unfolding in the U.S. economy promise to make for an exciting year ahead. But a variety of events outside of the U.S. may be just as worth watching if not more so in 2017. For while shifts in U.S. fiscal policy will take time despite the lofty hopes of U.S. investors to the contrary, many forces of change are already well underway in a number of important hot spots around the globe. And given that the events in these countries and others that will also be worth watching in the coming year (Dutch and German elections, the Middle East, Canadian housing market just to name a few) collectively will influence nearly half of the global economy, their likely influence on U.S. investor portfolios cannot be overstated. And nowhere in the world will be more important in this regard in 2017 than China.
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Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.
Disclosure: I am/we are long TLT,PHYS,XLK.
Additional disclosure: I am long selected individual stocks. I also hold a meaningful allocation to cash at the present time.