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Political pessimism likely to dominate markets in 2017

Political risk will be a major investment theme this year, with several elections happening in Europe, but are stock markets pricing in more risk than is necessary?

There are several sources of political risk that may be worrying investors. President-elect Donald Trump's policies will be put to the test when he enters office later this month; several elections taking place across Europe this year where Eurosceptic parties could make gains, such as Marine le Pen's National Front party in France; and the U.K. will begin Brexit negotiations with the European Union.

Kamal Sharma, director & G10 FX strategist at BofA Merrill Lynch Global Research, warned that investors are concerned about Europe and issues such as Brexit.

"Political risk premium is a key story that dominates what investors are looking at, at the moment," he told CNBC's Squawk Box.

Mike Bell, global market strategist at JP Morgan, on the other hand, told CNBC's Street Signs said that the perceived political risks in Europe have been exaggerated.

"The market's pricing in a greater risk of political negative outcomes than is actually likely," he said.

"If you look at Germany for example, it's extremely unlikely that any anti-euro party gets control in Germany. Likewise in the Netherlands."

Bell also said that some of the concerns in the U.S. are overdone.

"You look at the U.S. economy, you've got consumer confidence that hasn't been at this level and rising since 1996. You've got the initial jobless claims which are the lowest they've been since 1971 and you've got both the ISM new orders components for manufacturing and non-manufacturing over 60, so the U.S. economy is heating up really quite nicely," he said.

Sharma, however, said markets were nervous at the moment ahead of Trump's inauguration.

"We don't know what Trump ultimately will bring on January 20th. There's been a lot of rhetoric," he said.

Stock markets in the U.S. and Europe rallied in the run-up to the end of 2016, but have been a little subdued this week. The European Stoxx 600 is up around 0.9 percent for the week, while the Dow Jones refuses to cross the 20,000 mark and is up around 0.69 percent for the week so far.

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