Business & Finance

Despite North Korea, political risks are considered to be declining in 2017, but what about 2018?

Despite North Korea, political risks are considered to be declining in 2017, but what about 2018?
September 11th, 2017
Author: Economic Voice Staff

The (geo)political news is currently dominated by North Korea. It is noteworthy that the impact of the former on equity markets is becoming less and shorter in time despite the escalation in the tensions.

Patrick Moonen, Principal Strategist Multi Asset, NN Investment Partners says:

Of course, these risks are part of our assessment of market dynamics and are taken into account in our market views. The strong fundamentals which would justify a more positive stance on equities are counterbalanced by these risks.

Remember that 2017 was supposed to be the ‘year of all-risks’ in the Eurozone with the elections in the Netherlands, France, Germany on top of the Brexit discussions. On Brexit, we can be short. Few progress has been made and the clock is ticking. Financial markets are not much bothered. UK equities trade primarily on international factors (GBP, commodities prices and Emerging Markets).

The European election cycle has gone well so far and in Germany the CDU of Merkel is likely to be the winner later this month. The question is: Who will be the main coalition partner? The FDP together with the Greens or the SPD in a Grand Coalition? This choice could, in joining forces with other countries like France, set the stage for a deepening of the Eurozone institutions.

Graph 1 (PD)

In the US, the trend was the other way round. From a Trump reflation trade to a powerless government that thus far did not accomplish much. The odds might change in 2018 with on one hand the elections in Italy weighing on the Eurozone and on the other hand the Trump administration beating the by now rock bottom expectations.

Valuations are up for discussion. In an absolute sense, price earnings ratios are high but not extreme. Relative to fixed income instruments, equities are in line with or more attractive than historic averages. This is especially the case for the Eurozone and Japan. The US equity risk premium is somewhat below average. What is certain is the fact that long-term return expectations have shifted down. This is not surprising given the year-long rally we witnessed and the impact of a lower nominal growth environment. For the US and the Eurozone, the implied expected long term return is below 6% whereas in Japan it is above 6.5%. This is short of the historic trend rate of return.

So, we have a fundamentally positive picture combined with short term behavioral indicators that warrant some caution but what about the risks? Risks are geopolitical with North Korea. A further sharp drop in the USD is another one. Finally, a monetary policy error or market misinterpretation cannot be ruled out either and this would represent a serious shock to investors’ confidence.

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