Stocks are soaring and forecasts of global economic growth have gotten increasingly upbeat, but a number of key political risks are on the horizon, Barron's reports. Against a background of historically high equity valuations and low interest rates, just a small dose of bad news can send stocks and bonds plummeting.
Ian Bremmer, the founder and president of Eurasia Group, the oldest and largest consulting firm devoted to advising investors and business leaders on the impact of political risks around the world, shared his chief concerns with Barron's. They include these five, which he believes are being underestimated by investors: a major cyberattack, war with North Korea, President Trump blows up NAFTA, a new crisis erupts in the Middle East, and China's influence grows. "Geopolitics is very negative today," Bremmer tells Barron's. (For more, see also: 5 Market Predictions for 2018: Vanguard's Bogle.)
1. Major Cyberattack
The securities markets are "underestimating the likelihood of a major cyberattack against the critical infrastructure of a major country," Bremmer says. This risk is increasing, he believes, but investors aren't pricing it in. He finds this to be a more likely scenario than the breakout of an actual shooting war with North Korea.
2. War With North Korea
Bremmer gives very low odds to a preemptive military strike against North Korea by the U.S. The real risk, in his opinion, is that a series of mistakes and miscalculations by either side will escalate into war. Any attempt to remove North Korean dictator Kim Jong-Un from power is bound to provoke a massive conventional response against South Korea, never mind a nuclear attack, he says. While Kim Jong-Un "isn't suicidal," he has been effective at demonstrating that "North Korea's deterrence is real and unstoppable," per Bremmer. "People around Trump understand that," he adds.
3. Trump Blows Up NAFTA
"NAFTA should be modernized, and the Mexicans agree with that," Bremmer indicates. However, he continues, "Trump is not helping countries help us." Specifically, 2018 is a federal election year in Mexico, with its presidency among those offices up for a vote in July, and thus the political climate is not ripe for making heavy concessions to the U.S. on NAFTA. If Trump is too intransigent, and talks break down, that would be very damaging for Mexico, and may help vault a leftist candidate to its presidency, creating yet more problems for both countries, Bremmer adds.
4. Middle East Crisis Erupts
Iran is not getting as much foreign investment as they expected from the deal with the Obama administration to curtail their nuclear program. Meanwhile, Trump looks to impose sanctions aimed at punishing Iran for supporting terrorism. If hardliners respond by restarting nuclear weapons development, Bremmer fears that the odds of a military strike by Israel will increase. Meanwhile, he thinks that Saudi Arabia "is on borrowed time" and that the "massive reforms" proposed by their "impressive" new leader, Crown Prince Mohammed bin Salman, may not keep the lid on this potential powder keg. (For more, see also: Stock Market's 'Absurdly Good' Returns Will Worsen in 2018.)
5. China Gains More Clout
Trump's decision to exit the Trans-Pacific Partnership has given China another opportunity to increase its global economic and political clout, which already have been growing. Bremmer considers Xi Jinping to be by far the strongest Chinese leader since Mao, while the U.S. is considered by many around the world to be a "weak and inconsistent" leader. China also is buying influence around the world by "writing big checks," he adds. Also, China's political system allows it to be a leader in the implementation of labor-saving technologies, while also maintaining widespread labor inefficiencies in the pursuit of high employment and social stability, things the U.S. government cannot do, Bremmer notes.
'Susceptible to Any Shocks'
The World Bank recently raised its forecast of global economic growth, while warning that such a rosy outlook means that the preponderance of risks are on the downside, Bloomberg reports. In 2017, worldwide GDP expanded by roughly 3%, the best pace since 2011, per both sources, with 3.1% growth now forecasted for 2018.
Meanwhile, technical analyst Michael Kahn sees the most overbought conditions in the S&P 500 Index (SPX) since at least the 1970s, per his column in Barron's. While this does not preclude further gains in 2018, sending stocks into even more overbought territory, "it does mean that the market is susceptible to any shocks from within or without," he warns.
Nonetheless, according to research by LPL Financial, "the stock market tends to be resilient to crises, and the market's reaction is greatly impacted by where the economy is in the business cycle." Thus, "the biggest declines tend to be associated with economic weakness."
Based on their analysis of crises since 1950, and using the Dow Jones Industrial Average (DJIA) as a barometer of the U.S. stock market, they found that the initial reactions tended to be negative, with a median first day drop of 2.3%, but a median 5% rise after 22 days. The big stock market declines associated with the Arab Oil Embargo of 1973, President Nixon's resignation in 1974, the Hunt Brothers silver crash of 1980, Iraq's invasion of Kuwait in 1990, 9/11 in 2001, and the collapse of Lehman Brothers in 2008 all were in or around recessionary periods, per LPL.