Published By Brett Carson
Last year saw financial markets alternating between an uneasy calm and turbulence, with 2017 expecting much of the same. Developed markets are facing a paradigm shift as the U.K. initiates its exit from the European Union and the United States’ transition to the Trump administration brings political and policy risks to the fore.
What’s more, Europe enters into the unknown as anti-globalism, anti-trade and euro-skepticism could influence major elections in the Netherlands, France and Germany, which represent nearly 56 percent of the eurozone economy. China, too, is teetering on the edge of a debt bubble as the country has expanded its debt at an alarmingly fast rate despite slowing economic growth. Here are three events to focus on as the year unfolds.
The Trump presidency. What does President Donald Trump mean for the markets? This is a common question asked by investors, but no one really knows. Markets have been dealt a wild card and the varied expectations have already pushed the Dow Jones industrial average, the Standard & Poor’s 500 index and Nasdaq composite to record highs.
Driving the market upward is the expectation that policymaking over the next four years will be substantially different from the past eight and kick-start growth domestically. Of course, this all depends on Trump and his team’s ability to execute on their goals but the president’s intended tax cuts and infrastructure spending have certainly fueled the optimistic investor sentiment that helped push our domestic indices to their aforementioned highs.
Doubts remain over Trump’s ability to move these bills through Congress given country’s current debt burden. What’s more, his plans to renegotiate trade deals could have an impact on the United States’ position in the global economy, potentially reducing exports and business investment. Given these unknowns, investors should remain focused on the fundamentals of the market – and not rely on what-ifs.
Oil’s outlook. The oil markets are expected to be equally uncertain and volatile in 2017 as investors deal with the supply glut, proposed production cuts, shale inventory in the U.S. and sluggish growth in China and India. The Energy Information Agency forecasts global oil demand to increase by 1.6 million barrels per day this year, while global inventory builds are likely to average 0.4 million barrels per day. The first half of 2017 is expected to have higher builds but OPEC’s cuts, should the cartel follow the agreed upon plan, will likely taper the latter part of the year.
There are many factors that could upset this delicate balance bringing volatility to oil prices. First, OPEC countries may not be able to sustain production cuts as many of the member states are under budget constraints, making it difficult for them to follow along. Second, higher oil prices will incentivize shale producers to increase production which, in turn, may provoke OPEC nations to flood the market, leading to oversupply and a return to lower prices.
Lastly, significant political turmoil in Europe, demonetization in India and tightening regulations in China could shrink demand. The EIA predicts West Texas Intermediate crude to average about $51 per barrel while the World Bank forecasts a slightly more optimistic price of $55 per barrel.
Eurozone banking sector stress. Europe continues to deal with unresolved issues from the 2008 financial crisis. Today, one of the primary reasons for sluggish growth in the region has been the massive number of bad loans lurking on the books of some of the largest banks in the European Union, effectively stymieing their ability to create new credit.
The World Bank estimates that the ratio of non-performing loans to gross loans in Europe reached 4.3 percent in 2015, a small uptick from where it stood during the 2008 financial crisis. Among the $3 trillion in stressed loan assets worldwide, European banks are saddled with more than 43 percent of the bad debt. What’s more, Spain, Portugal and Italy combined have $600 billion, or almost half of the EU’s total non-performing debt, and Italy alone holds $400 billion, amounting to 18 percent of all bank loans in the country. Last month, the country’s oldest institution, Monte-dei-Paschi, tried to secure private capital of 5 billion euros to recapitalize its operations but failed and was forced to opt for state intervention.
The European Central Bank’s rules on bailouts are quite stringent, forcing bond investors to first suffer losses. However, the recent treatment of Monte-dei-Paschi by the ECB could perhaps be used as a model for other bank bailouts to prevent an anti-euro backlash across the region.
Indeed, many European nations have elections this year that could determine the future of the EU. The resolution to the banking crisis will be critical to the region as well as euro as a currency.
The bottom line. Significant uncertainty exists in the markets. Domestically, it could come from Trump and his agenda. Internationally, the eurozone is still facing an uphill battle in its banking sector as non-performing loans are reaching cautionary levels. Without a solution, the potential for a banking crisis is very real.
This, combined with the political unrest across the region, places the future of the EU in doubt. The supply of oil will also be closely watched as investors monitor the impact of OPEC’s historical production cut. A supply and demand balance would be seen as a positive for an industry that has suffered from depressed earnings and falling share prices.
Ultimately, there are a significant number of unknowns this year and markets are likely to remain volatile as investors react to new information. Investors should carefully consider these risks and develop a comprehensive wealth plan that encompasses their unique situation and risk tolerance.