Global Investing Hot Spots

Investors beware: 5 risks that can unravel the EU in 2017

Bryan Borzykowski, special to

Bullishness isn't just about the U.S. anymore.

Investors are showing some excitement about international stocks. Developed market stocks outside the U.S. are up almost 5 percent, keeping pace with the S&P 500. A big part of the outperformance: European companies are growing earnings for the first time in years. Meanwhile, investors have been more evenly balancing stock bets between the United States and the rest of the world since the beginning of the year.

Experts say it will be a make-or-break year for Europe, and so far institutions and financial advisors are betting on the Continent making it. "If the European Union can survive these hurdles and make it through to 2018, then we should see a positive mid-single-digit return this time next year," said Jeff Schulze, an investment strategist at ClearBridge Investments.

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But with the world's attention focused on President Donald Trump, it's easy to forget that Europe is still going through some immense turmoil. From elections to lingering Euro zone debt-crisis issues, investors may be quick to take profits. So it's important to ask: What could kill the rally in European stocks? Here is a breakdown of five of the biggest risks facing Europe today.

1. Election uncertainty

There should be four elections this year, with France and Germany being the ones to watch. Italy will likely have an election, too, though one hasn't yet been called, while the Netherlands kick things off on March 15.

All eyes are currently on France, where Marine Le Pen, leader of far-right party National Front, is expected to win the country's first round of elections on April 23. She's is trailing by between 20 percent and 30 percent in the polls when pitted against Emmanuel Macron, who is also expected to make it through to the second election, which takes place on May 7.

However unlikely it is that she'll become France's next president, many people are worried about a Trump-like surprise. Since the election, the country's 10-year government bond has climbed by about 45 basis points, which is an indication that at least some people are concerned. "You're seeing a spike in yields of French bonds over German bonds," Schulze said. "It appears that some individuals in the fixed-income market are nervous about this election."

HSBC: Underweight on Europe
HSBC: Underweight on Europe

If Le Pen wins, it's almost certain that France will leave the Euro zone, as she has been vocal about a "Frexit." And that's bad news for Europe. "If France, which is the second-largest economy in the region, withdraws, then the Euro zone is probably dead," said Norman Raschkowan, president and portfolio manager at Toronto's TenSquared Investments.

Germany is facing a rise in far-right sentiment as well, with the country's Alternative for Deutschland party gaining ground in polls, but it's still trailing well behind Angela Merkel's Christian Democrats party and Martin Schulz's Social Democrats. With improving economic data and growing anti-Trump sentiment in Germany, Raschkowan doesn't think it's nearly as big of a threat as Le Pen is in France.

2. The rise in populism

What is a concern, though, is the fact that these nationalistic, anti-immigrant parties are gaining ground in the first place. There's clearly a trend toward populism, which has partly been driven by high-profile terrorist attacks in France and Germany, economic malaise in certain countries and right-wing politicians lambasting the European Union. In the Netherlands, the far-right party candidate Geert Wilders is currently the front-runner in a vote that will be the latest test for the antiestablishment sentiment currently sweeping the globe.

It's unlikely we'll see much fallout in the short term, but it could be a significant issue over the long term, ClearBridge's Schulze said. If economic inequality between northern and southern Europe worsens, then people could rise up, borders could close, and more countries could leave the Euro zone.

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Nationalism hurts Europe's economy and its stock markets, Raschkowan said. Hungary, Poland and Turkey have already started taking a more hard-line approach to immigration, and that's undermining its economic potential, he said. Poland's GDP growth, for instance, is expected to grow at its slowest pace since 2013. While these countries may not get the attention that other European nations do, there is worry that their nationalistic policies could spread.

3. Greece teetering on another default

Europe's economy has certainly improved over the last few years — Focus Economics thinks it will grow by 1.5 percent in 2017 and 2018 — but there are still several pockets of concern. One big question mark continues to be Greece, which must agree to new austerity measures by Feb. 20. If it doesn't and it appears that it won't, it could end up missing a $7 billion euro payment due in July.

The problem is that Greeks don't want more austerity measures. The country has been reducing its spending for several years now — it's lost 27 percent of its GDP since 2007, Schulze said — and politicians and citizens say the cutting can't continue. "That's the standoff – European finance ministers want to see more spending cuts and tax increases, while Tsipras [the prime minister] is claiming that austerity has gone too far and that there's no more they can cut," he said.

European governments may ultimately have to admit that austerity hasn't worked, Raschkowan said. Something will likely get worked out before it defaults, he said, but in a worst-case scenario, Greece will pull out of the Euro zone, which would then force governments to write down its debt. "It has to get to a point where the rest of Europe accepts a write-off and accepts that it was a bad investment," said Raschkowan. "Until they do, the Greeks will never acknowledge that the rest of Europe has made any effort to help them." While that might seem drastic, Europe's banking system is much stronger than it was in 2011, when the Greek crisis first materialized, so it can handle the write-down.

4. Brexit aftershocks

It's expected that Article 50 will be triggered on March 9 or 10, officially kicking off Britain's exit from the European Union. Other than the two days after the referendum, markets haven't reacted negatively to Brexit — the FTSE 100 is up 16 percent since the vote last June — though that could change if the breakup becomes heated, said Erik Esselink, a portfolio manager with Invesco Asset Management. "There is a risk that we'll go through a period of mud-throwing between the EU and the U.K., and that's not good for either of them," he said.

While Britain leaving the EU isn't as damaging as another country leaving — the U.K. has its own currency, at least — it will still be a challenging period for the region. London's economy is dependent on European labor, and if that ends, then it could run into big problems.

Brexit has also helped bring other Euro zone countries together, and that could result in tougher negotiations with the U.K., Raschkowan said. "(Britain) was hoping that they could promote infighting amongst the Europeans and that would then strengthen their hand," he said. "But they've actually become more unified, and that could make it tougher for the U.K."

5. The Trump effect

There's one other issue to watch out for: America's impact on Europe, which is something Esselink is particularly concerned about. If Trump's tough talk on trade becomes a reality — he's already threatened to impose a 35 percent tax on German autos imported to the United States — it could throw many countries, though especially Germany, into turmoil. "Could there be an event where he puts an import duty on German cars?" asked Esselink. "Is there a chance he uses Germany like he's been using Mexico and China — as the poster children of what's wrong with the U.S.?"

America's attitude toward Europe and how Europe reacts to a more isolationist America could have a big impact on the region's future. "That's the thing I really worry about," he said. "The impact of the U.S. president."

By Bryan Borzykowski, special to