These are the next risk events for investors now

2017 held a clutch of potential political risks from the Dutch general election to the French presidential election to the U.K.’s surprise snap election. In Germany’s general election, Chancellor Angela Merkel’s conservative alliance was the biggest winner, but collapse in support for mainstream parties adds uncertainty over the country’s political future.

Now that Germans have gone to the polls, what’s next for investors to watch? We now know the Federal Reserve will put its massive $4.5 trillion balance sheet on a diet starting in October. Central banks and their easing plans are, of course, the perennial cloud on the horizon. But there’s the chance that subject is blotting out some other, more overlooked, events. Here’s a look at what analysts say have the potential to make markets sit up and listen.

Chinese Party Congress and credit concerns
The Communist Party’s marquee political event—held every five years—begins on Oct. 18 and will run for one week. The party will undertake a traditional reshuffling of leadership, which should allow President Xi Jingping to further consolidate his power. Investors will watch for any updates on the party’s “Belt and Road Initiative,” to which China has pledged than $100 billion for ports, pipelines and other infrastructure projects to bolster trade connections with more than 64 countries.

“China is obviously a very important economy and [the event] will be closely watched by investors, especially because emerging-market assets this year have done really well—be it currencies, be it debt or be it equities,” said Sven Balzer, senior strategy manager at Coutts, in an interview.

The escalating, nonperforming loan—or bad debt—situation in the world’s second-largest economy may come under more scrutiny after the party congress concludes, said Eoin Murray, head of investment at Hermes Investment Management.

The “Chinese credit boom is on a par with some of the credit booms that have exploded in the Western world over the last couple of decades. There is a chance that it will unwind in an ungraceful fashion,” he said.

The Chinese government has been working to rein in corporate leverage. Murray said keep watch the impact of slowing credit growth on that economy. “We might get through toward the end of this year before we see further reductions in GDP growth figures in China,” said Murray.

European equity strategists at Deutsche Bank recently said slowing Chinese credit growth, along with strengthening of the renminbi trade-weighted exchange rate, will likely hurt Chinese manufacturing activity in the second half of 2017. That, along with expectations for a copper prices pulling back, led the strategists to downgrade the European mining sector—which includes Antofagasta ANTO, -1.97% Glencore GLEN, -0.37% GLCNF, -0.21% and Anglo American PLC AAL, -2.10% —as China is a major buyer of industrial and precious metals.

EU summit
European Union leaders are slated to gather on Oct. 18-19 in Brussels and, of course, the U.K.’s pending exit from the trade bloc, or Brexit, will be a hot topic. The European Council will review how much progress has been made so far in the negotiations.

“Sufficient progress” needs to be made in first phase of talks before moving to the second, according to the EU’s guidelines. Clarifying the rights of citizens and entities affected by Brexit and the settling of the so-called divorce bill are the EU’s priorities in the first phase of negotiations.

U.K. Prime Minister Theresa May will address her Conservative Party members at their annual conference on Oct. 1 through 4. May has faced heavy criticism about her leadership and her vision for Brexit after the Tories lost their parliamentary majority in June’s snap election.

“If [May] fails to make proposals that would allow the EU summit to at least signal some form of progress, concerns about the chances of agreeing any deal might rise, with the usual effects, in particular on sterling,” said Citi’s European economics team in a recent note. Sterling, or the British pound GBPUSD, +0.0963% is still roughly 10% lower than since the U.K.’s Brexit referendum in June 2016.

Structural reforms in France
Along with Germany, France is the kingpin in the European Union. The unexpected win by French political upstart François Macron in the country’s presidential race in May delivered an electoral surprise and sent French PX1, -0.32% stocks higher. But the centrist president is facing headwinds as he tries to change labor regulations to improve productivity in Europe’s third-largest economy. Protests against Macron’s plans have been held in cities throughout France.

But there may be an upside for markets stemming from Macron’s push for change.

“If France really gets momentum and starts to deliver on the reform side—which the German government has been expecting for many years now—there might be voices in Germany that say ‘Maybe we should find ways to help France to make it easier for them to implement their reforms,” said Balzer at Coutts.

Merkel and German Finance Minister Wolfgang Schäuble have backed the idea of turning the European Stability Mechanism, the eurozone’s permanent rescue fund, into a type of European monetary fund aimed at fostering structural, economic reforms.

“That would be positive for European momentum and bring down the risk premium [in European equities] even further from where it has come down now and, to a certain extent, in bonds in more peripheral countries like Spain and Portugal,” said Balzer, noting that political risk drove up risk premiums in stocks earlier in the year.

U.S. tax cuts
Investor disappointment over the lack of significant progress on U.S. President Donald Trump’s plans to cut various taxes, including the corporate tax rate, have at times dragged down global equity markets and the U.S. dollar DXY, +0.44% since last year’s U.S. presidential election. A recent Business Roundtable survey said CEOs consider the U.S. tax system as a key disadvantage for the U.S. economy relative to other major economies, although others note that after deductions and other measures, the corporate rate is seen largely in line with other major economies.

The Trump administration says it’s moving closer to unveiling a detailed tax package.

“As long as headlines continue to indicate political traction, we believe investors are likely to start pricing in higher probability of tax reform,” J.P. Morgan’s U.S. equity strategy team said in a research note.

A drop in the statutory corporate tax rate to 25% from 35% could potentially boost the S&P 500 index SPX, -0.09% by more than 150 points, they projected.

Reforms in Washington could also trigger a widespread rotation in equity markets. “Value style has the highest domestic-revenue exposure, is the largest beneficiary of a lower federal tax rate and currently has the highest level of short interest—all of which could be a catalyst for a potential short squeeze,” and send those stocks flying higher, they said.

Shares of financial companies, namely regional banks and consumer finance firms, consumer goods and telecom companies would benefit the most as they have a high effective tax rate, said J.P. Morgan. But shares of tech, health care and consumer staples companies with significant overseas profits are likely to benefit the least as they already have a low effective tax rate.

Of course, the Trump administration still faces a rocky road to getting fresh tax-cuts signed into law. The tax reform process may take a back seat to fourth-quarter legislative deadlines, including government-funding issues, said Morgan Stanley strategists in a research note.

“We’re skeptical of bipartisanship & Q4 is a logjam, but tax reform should make slow progress toward 2018 passage even as failure risks remain,” the Morgan Stanley team wrote. “Deficit expansion is part of the deal, but limited in scope & stimulus. Yet this may be enough for risk assets near term.”
Source: MarketWatch

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