Equity markets are heading into mid-year with lackluster gains. While few investors have been thrilled with this year’s performance, it could be much worse. We have yet to see a significant correction, equity markets remain within a few percentage points of all-time highs and volatility remains low.

Many clients have been asking: What could change? Or put differently, what could lead to a more severe market correction? So, I figured it was time for my annual look at the market risks that keep me up at night. While there’s a long list of things that could go wrong, here are four that I would focus on for the summer.

  1. Ukraine. There’s no way of knowing how events in Ukraine will play out, but what’s clear is that for now, the market is paying scant attention. Even during last week’s sell-off, market volatility, as measured by the VIX index, never got above 14. An escalation in Ukraine-related violence and more sanctions against Russia don’t appear to be priced into financial markets and would both likely lead to increased selling.
  2. Europe. With many of Europe’s former problem children enjoying all-time low bond yields, it seems a strange time to worry about Europe. However, while bond yields have dropped, risks remain. Sovereign debt levels continue to climb; growth, while improving, remains anemic; and the currency zone is flirting with deflation. Outside of the economic risks, there are growing political risks. The European parliamentary elections may illustrate just how much damage has been inflicted on the region’s main political parties. For example, while economic conditions in Greece have improved – from abysmal to merely poor – the political situation has not. The government is teetering, with a razor thin two-seat majority.
  1. China. My base case scenario is a modest deceleration in the Chinese economy. So far, while the country’s economic data has been weak, it has conformed to that scenario. That said, the Chinese government is attempting a difficult balancing act: slow down the real estate market and credit expansion without cratering growth. A sharp and unexpected drop in growth would not only pose a risk to China, but with China as the world’s second largest economy, it would pose a risk to the global economy as well.
  1. U.S. Bond Market. Why worry about interest rates with bond yields at six-month lows? Because, as everyone experienced last May, with rates at these levels, bond prices can reverse violently and abruptly. I would focus on two near-term and interrelated risks related to the bond market: a change in Federal Reserve (Fed) language and aggressive selling of bond funds by retail investors. Year-to-date, investors have been piling into bond bunds. However, even a subtle shift in the Fed’s tone could quickly change that pattern. The risk of retail outflows is heightened by the fact that many recent bond buyers are desperately seeking yield rather than committing to the asset class. A turn in rates could produce a quick turn in flows. (You can read more about the potential impact of the end of easy money in a new BlackRock Investment Institute paper I co-wrote, The Disappearing Act.)

To be sure, I do expect equities to move higher over the course of the year. But as I’ve discussed previously, given last year’s extreme multiple expansion, 2014 was always going to be a more difficult year for stocks. Any of the above could quickly turn a difficult year into a bad one.

Sources: Bloomberg, BlackRock research

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog.

Investopedia and BlackRock have or may have had an advertising relationship, either directly or indirectly. This post is not paid for or sponsored by BlackRock, and is separate from any advertising partnership that may exist between the companies. The views reflected within are solely those of BlackRock and their Authors.

Related Articles
  1. Investing News

    Negative Interest Rates and QE: 3 Economic Risks

    Along with quantitative easing (QE), unconventional monetary tools are meant to stimulate economic activity, growth, and a moderate level of inflation.
  2. Investing Basics

    Contingent Convertible Bonds: Bumpy Ride Ahead

    European banks' CoCos are in crisis. What investors who hold these high-reward but high-risk bonds should know.
  3. Economics

    How Negative Interest Rates Work

    Policymakers in Europe go for the unconventional: negative interest. What could happen?
  4. Stock Analysis

    The Top 10 Small-Cap Stocks for 2016 (ATI, ARCB)

    Discover the top 10 small-cap stocks expected to grow in 2016, complete with summaries and growth outlooks for each company and its expected price target.
  5. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  6. Investing

    Don't Freak Out Over Black Swans; Be Prepared

    Could 2016 be a big year for black swans? Who knows? Here's what black swans are, how they can devastate the unprepared, and how the prepared can emerge unscathed.
  7. Fundamental Analysis

    3 Times the FOMC Got It Right This Century

    Learn about three times that the Federal Open Market Committee (FOMC) and the Federal Reserve took positive steps to help the economy in the 21st century.
  8. Fundamental Analysis

    Quantitative Easing Report Card in 2016

    Find out why quantitative easing has not worked, despite the best efforts of the Federal Reserve, and how it has fueled the national debt problem.
  9. Products and Investments

    The One Thing Your Portfolio Must Always Have

    Portfolio diversification is essential in any situation, but especially so as the market finally returns to fundamentals.
  10. Markets

    Is It Time To Buy Emerging Markets? (EEM)

    The majority of emerging markets are dependent on natural resources, delaying a long-term recovery until commodity markets end historic downtrends.
RELATED FAQS
  1. What is a basis point (BPS)?

    A basis point is a unit of measure used in finance to describe the percentage change in the value or rate of a financial ... Read Full Answer >>
  2. Is China a developed country?

    Despite having the world's second-largest economy and third-largest military, China is still, as of 2015, not classified ... Read Full Answer >>
  3. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
  4. Does the IRS charge interest on penalties?

    The Internal Revenue Service (IRS) charges interest on any overdue taxes owed, but it does not charge interest on penalties. ... Read Full Answer >>
  5. Do hedge funds invest in bonds?

    Hedge funds have the freedom to deploy their capital in virtually any manner. They can use leverage, invest in non-publicly ... Read Full Answer >>
  6. Do mutual funds pay dividends or interest?

    Depending on the type of investments included in the portfolio, mutual funds may pay dividends, interest, or both. Types ... Read Full Answer >>
Hot Definitions
  1. Harry Potter Stock Index

    A collection of stocks from companies related to the "Harry Potter" series franchise. Created by StockPickr, this index seeks ...
  2. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  3. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  4. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  5. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
Trading Center