Wednesday 7 December 2016

Fears ballot box shocks will spark markets mayhem

Rise in populism has become one of the biggest threat to exchanges everywhere

Published 27/11/2016 | 02:30

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Years of stock market mayhem could be around the corner if the rise of populism in the US and Britain spreads to Europe. Such a development could see a return to 2011 when the European debt crisis was at its peak, experts fear.

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In 2011, concerns about the future of the eurozone played havoc with stock markets. Fears that the eurozone was about to collapse - and with it, the euro - sent investors rushing to so-called 'safe haven' investments in a desperate bid to protect their money.

Britain's vote to leave the European Union and Donald Trump's surprise victory in the US presidential elections have sparked concerns that populism and nationalism are gaining ground and that anti-EU and anti-establishment parties could become more dominant as a result.

It is this rise in populism - that is, the belief in the power of ordinary people and in their right to have power over the government - which is one of the biggest threats to stock markets over the next year, according to Brian O'Reilly, head of global investment strategy with Davy.

"The biggest risk we can see 12 months out is the European elections, including the elections in France, Italy and Germany," said O'Reilly.

"We are seeing a wave of populist moves in Britain and the US and the stock market is fretting over how that will translate into Europe. Given the fragile nature of the eurozone, this could be a problem. If we saw a surprise result in the French elections where France looks to detangle itself from Europe, others could follow. All of a sudden, we could be back to the 2011 situation in stock markets - which wouldn't be good for investors."

Election watersheds

There are a number of major elections taking place in the EU over the next year.

A constitutional referendum takes place in Italy on December 4. The aim of that referendum is to make Italy's government more stable and efficient through a series of reforms to the constitution. If rejected, that referendum could send stock markets and bonds tumbling - and weaken the euro.

The first round of the French presidential elections will be held on April 23. Although the Republican candidate, Alain Juppe, and former prime minister Francois Fillon, are amongst those being tipped to win the election, recent opinion polls have shown a surge in support for Marine Le Pen - the leader of the far-right party Front National. Le Pen, an open critic of the EU, has vowed to hold a referendum on whether France stays in or leaves the EU - if she is elected president.

Meanwhile, German Chancellor Angela Merkel is gearing up for the German general elections next autumn when she will seek re-election. One of her biggest challenges will be to combat the surge in far-right extremism. The right-wing populist party, Alternative for Germany, was a big winner in the regional elections in Germany last September, even beating Merkel's Christian Democrat party in her own home state.

Economists have warned that weak economic growth across much of Europe could play into the hands of populists in these elections as disillusioned voters blame their governments for failing to deliver on promises.

The shares of eurozone-based companies could take a big hit if the rise in populism triggers - or increases concerns of - a break-up of the eurozone. So too would the shares of any companies with a lot of exposure to the European economy.

The euro itself will suffer if populism wins out in a country such as Italy, according to Peter Brown, founder of Baggot Investment Partners and a director with the Institute of Investing and Financial Trading (IIFT) in Dublin.

"The outlook for the euro is much worse than sterling," said Brown. "The danger is that the euro could depreciate against the sterling."

Should the rise in populism eventually lead to the collapse of the euro - with countries reinstating their own currencies, the eurozone could be plunged into recession. This of course would be disastrous for stock markets - and its many investors. In late 2011, when fears of a break-up of the eurozone was running high, the then European Commission president Jose Manuel Barroso warned that the collapse of the euro would wipe out half the value of the eurozone economy.

Trump

The other big issue for stock markets over the next year is the impact which Trump will have on the world economy.

"The really interesting theme going into 2017 is any growing divergence between what's happening in Europe and what's happening in the US - if Trump pursues an expansionary policy," said Brown. "The big question is: Will Trump's policies encourage Mario Draghi to change his mind and lift off the hair shirt?"

Draghi has largely stuck to the austerity path since he became president of the European Central Bank (ECB) in November 2011. Should he soften his stance and increase spending, markets could react favourably - as long as he doesn't damage the European economy in doing so. The chances of Draghi doing a complete U-turn on austerity however are probably slim.

"The scramble to decipher what a Trump presidency means for the economy and markets is now on but realistically the current policy fog will likely only slowly lift as we find out who the key figures are in the new administration," said Pat McCormack, head of wealth and investment with Barclays Ireland. "Investors should focus on the underlying global economy. The global economic backdrop continues to seem favourable for those who would lean their investment portfolios towards stocks and away from bonds."

As always, investors should not to make any rash moves "It is natural for investors to try and get ahead of the game," said Jeremy Lawson, chief economist with Standard Life Investments. "However, it is also important to exercise caution. All presidents govern differently from their campaigns but a Trump presidency carries more uncertainties than usual given his non-traditional approach."

Oil

This Wednesday OPEC's meeting will be keenly watched by investors in the hope that Opec reaches a deal to cut oil production - and stabilise the oil market. Oil prices rose to about US$49 a barrel mark early last week on expectations that Opec would reach an agreement.

"The price of oil is critical," said Brown. "The break-even point for producers in oil is around the mid-fifties. Oil at $45 a barrel is not good for oil-producing countries. Banks have lent a lot of money to oil-producing countries. If oil prices go up, things should be OK - as those countries should be able to restructure their debt. But if oil prices drop to something like $35 a barrel by the end of 2017, there's a lot of trouble ahead for banks, oil producers, emerging markets - and investors."

Brexit

Brexit is the other big unknown for investors. It is expected to be late March 2017 when Britain begins the process of leaving the EU. Early last week, the British prime minister Theresa May told business leaders that although she does not wish to delay leaving the EU, she wants to avoid a "cliff edge" after Brexit. She also pledged to further cut corporation tax so that Britain would have the lowest corporation tax rate of the world's 20 biggest economies. It remains to be seen whether Britain will be stronger or weaker after Brexit. Its retrenchment from Europe will certainly not be easy - and many investors and British companies are already feeling pain.

"2017 will be a massive year for world stock markets," said Brown. "Stock markets could go either way - depending on what happens with Trump and Brexit. The important message for investors is not to get locked into any investments."

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