• Wealth Management

10 Worries for 2018

While there is only a small chance any of these events will come to pass, the market impact would be large if one of them did.

Looking across the geopolitical landscape, I see 10 scenarios that could potentially disrupt markets this year. While the likelihood of these coming to pass is relatively small, the impact of some of them could be quite large. These are the top 10 worries that keep me awake at night, including some warning signs to watch for:

1. U.S. foreign policy misstep

It is difficult to know how leaders respond to crises until they are confronted with one. The Trump administration has not yet been tested. Should such a situation arise, the administration will need to rely on a State Department that has seen 19 of 38 senior officers exit and has only 11 of 44 political appointees in place. With a depleted corps of professional crisis managers and frequent turnover in the West Wing, the risk of a foreign policy misstep is greater than normal.

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2. The new tax law fails to provide a major growth boost

Investors are excited about the new tax law, which includes a large corporate tax reduction that should foster investment, encourage capital return to shareholders and bring U.S. rates in line with global competitors. But investors may be too optimistic about the new law’s ability to stimulate the overall economy. Plus much of the tax benefit to earnings may already be priced into stocks. If the law doesn’t meet expectations, the market could fall.  

3. The tax law has unforeseen consequences

There are some features of the new tax law that could actually impede growth. For example, elimination of the state and local tax deduction may drive down housing prices in some high tax states like California, Florida, New Jersey, New York and Oregon. That could have a negative wealth effect, slowing consumer demand. The law also limits the deductibility of corporate interest payments to no more than 30% of cash flow. That means companies with a lot of debt could have to pay more in taxes during an economic downturn.

4. North Korea containment fails

Global concern over North Korea spiked this year following a series of increasingly provocative missile tests. The most recent arguably shows that North Korea can strike the U.S. West Coast. Dialogue between the U.S. and North Korean leadership has been incendiary at times this year. Current tensions could easily spill over into small-scale military confrontation on the Korean peninsula. The big risk is such a skirmish escalates, even potentially to a nuclear conflict.

5. Contagion from a China slowdown

Warnings about China’s high debt levels and weak financial system are familiar. So far, China’s policymakers have avoided a crisis, but China’s growth is likely to slow in the coming year. While a moderate slowdown would not be a cause for concern, if the economy were to suffer a serious blow, investors should consider two risks. First, high debt levels could lead to a wave of bankruptcies. Second, the economic damage could spread, given China’s connections to the rest of the Asia and emerging markets.

6. Critical cyberattack

Pick the venue. A large-scale cyberattack against the financial system, power grid, communications network or energy infrastructure could trigger a market meltdown and possibly an international crisis. Most of the critical systems in the U.S. have vulnerabilities that malicious foreign actors can exploit. There is also the chance that a small-scale hack could escalate unintentionally.

7. Terrorism involving weapons of mass destruction

Terrorism is an unfortunate feature of modern times, but societies around the world have become remarkably resilient. Markets rarely respond to terror attacks, as the immediate effects are usually overshadowed by economic fundamentals in short order. Terrorist attacks involving a biological, chemical or nuclear weapon that killed tens or hundreds of thousands would be a game changer that could trigger a new war or a reorganization of global alliances.

8. Russian intrigue destabilizes global status quo

The invasion of Crimea, intervention in Syria and the attempts to manipulate the U.S. elections all signal Russia’s desire to adopt a more assertive international role. With oil prices down and reforms stalled, the strategic shift from economics to nationalism is hardly a surprise. The West will continue to brush up against Russian interference in Eastern Europe, the Middle East and even at home.

9. Middle East’s 100 Years’ War spreads

Saudi Arabia and Iran are vying to control the region. Yemen and Syria represent the primary fronts, but violence is prominent in Iraq and Lebanon while refugee pressures mount in Jordan and Turkey. Global energy supplies have diversified away from the region, but a serious escalation could still trigger a spike in oil prices. Risk is ascendant across the region.

10. Trade grinds to a halt

The past year has seen one of the biggest retreats in global trade since the end of the Cold War. The United Kingdom opted to exit the European Union. The U.S. abandoned the Trans-Pacific Partnership and opened NAFTA renegotiations. The World Trade Organization reported that protectionism in 2016 grew at the fastest pace since the financial crisis. The rise of anti-establishment and nationalist forces around the globe increases the likelihood of a major trade dispute and resulting market disruption.