Investors are focusing on upcoming European elections as risks, but the French outcome matters much more than what happens in Germany, the Netherlands, or Italy. Concerns about China’s economy and the Federal Reserve’s interest-rate decisions were blamed for a stock market sell-off last year They could make a comeback as big risks, according to leaders at PGIM
2016 was not a great year for forecasting.
The UK’s decision to leave the European Union, and President Donald Trump’s win despite what the polls showed, humbled many people who were sure that the opposite outcomes would happen.
With that in mind, managers at PGIM, the group of Prudential’s investment management businesses that oversees $1 trillion in assets, discussed events that are being underplayed but have a real possibility of happening and should be more worrying right now.
For Mike Lillard, the chief investment officer at PGIM Fixed Income, the Federal Reserve’s response to faster economic growth could be a risk during the next couple of years.
“Our concern would be that over the next couple of years, the Fed overtightens,” Lillard said at a panel discussion in New York on Wednesday.
In congressional testimony on Tuesday, Fed Chair Janet Yellen said raising interest rates too slowly could destabilize financial markets and trigger a recession. But the reverse – hiking too quickly – is the more problematic scenario, as Business Insider’s Pedro da Costa also argued.
Lillard said the risk of a US recession could escalate three years from now. Despite the prospects of higher interest rates from the Federal Reserve, he still finds rates attractive. But he is looking to lower his credit risk because there are probable events that markets have not fully priced in.
The European elections are being lumped together as a general risk to markets, but France is the one that really matters, according to Eric Adler, the CEO of PGIM real estate.
Marine Le Pen, the leader of the nationalist Front National, supports a referendum on France’s membership in the European Union. Her speech early in February outlining her vision for France unnerved financial markets in the region.
“The idea that Marine Le Pen could win will blow the euro up,” Adler said, referring to the geographical area. He said with the UK’s vote to exit the EU, Germany and France are really the only other two countries holding the union together.
“If France were to pull out because of a referendum that’s instigated by Marine Le Pen and her victory, I think that ends the euro
If France were to pull out because of a referendum that’s instigated by Marine Le Pen and her victory, I think that ends the euro.
, which really plunges everything into uncertainty globally at least for a while,” Adler said.
This is not his base case, however.
“I’m really focused on it because I’ve been wrong twice in 2016 on things that weren’t supposed to happen,” he added.
On Thursday, the betting odds showed Marine Le Pen had a 34% chance of winning, versus 43% for Emmanuel Macron, her leading centrist opponent, according to Bloomberg.
Ed Campbell, the portfolio manager for QMA, a business of Prudential Financial, said Le Pen’s odds are similar to Trump’s on election day.
“With all the focus on US politics and the spread of populism across Western democracies where we had Brexit, we’ve had Trump, and now we’re concerned about the European political calendar, I think China political risks have fallen off the radar,” Campbell said.
Last year, Chinese officials unleashed major stimulus measures to boost the economy, cutting interest rates and increasing spending. But investors have become complacent about risks to China’s economic growth, especially in the run-up to the Communist Party of China’s congress that could create a leadership transition, Campbell said.
“I think the risk is that we see another China-related growth scare in 2017,” Campbell said. He recalled the stock market sell-off in January 2016 that was partly attributed to instability in China.