Five Things Investors Have to Worry About in 2012

Investors can blame Europe for choking off stock market gains in 2011, but there’s a growing list of geopolitical flashpoints lurking in 2012—and any one of them could pose a risk to stocks.

Globe wrapped in barbed wire
Photo: Dieter Spannknebel | Photodisc | Getty Images
Globe wrapped in barbed wire

Market guru Laszlo Birinyi said there already is a long list of “known unknowns” coming in 2012, and many of them involve elections in places like France, Mexico, India and Russia.

Of course, the U.S. presidential election is also on the horizon in November, and there was plenty of domestic political squabbling that swamped the market this past year.

But looking outside the U.S., the geopolitical landscape has become a bigger source of focus for U.S. investors, who are starting to feel a bit better about the U.S. economy and the investing environment at home.

Fears about contagion from Europe’s sovereign debt crisis will continue to dominate in 2012, as will concerns about a hard landing in China, and slow down in other emerging markets. Beyond that there are other situations that could easily progress to a point where they become factors for markets.

Here are five areas to watch for 2012:

  1. Conflict with Iran: The U.S. and other Western countries are moving to put economic sanctions on Iran for its nuclear weapons program. Tensions are rising and analysts worry about scenarios where Israel could take action against Iran, or that it could take some action to reduce the flow of world oil through the Straits of Hormuz, a key shipping channel between Iran and Oman. Either way, the worst case scenario drives oil prices higher, hurting the global economy and financial markets.
  2. North Korea’s New Kim:Kim Jong-un, the youngest son of Kim Jong-il, took over after his father died last Saturday. There is little known about the 28-year-old leader, but he now heads a secretive and closed off country with an advanced nuclear weapons program. There are reports he will head a ruling group that includes his uncle and the military.
  3. Iraq Civil War?: Just a day after the U.S. pulled out of Iraq, the country’s Shiite dominated government ordered the arrest of Sunni vice president Tariq al-Hashimi, accusing him of running death squads and assassinating public officials. The fragile coalition government is at risk of dissolving, creating more instability in the Middle East and an unknown for oil supplies.
  4. Pakistan-U.S. alliance weakens: The bristly relationship between the U.S. and Pakistan worsened after U.S. and NATO troops accidentally killed Pakistani soldiers on the Afghanistan border. The relationship is critical to the U.S. efforts in the war on terror and in keeping balance in its relationship with neighboring India, a U.S. ally. Recent rumors of a coup were quashed when President Zardari returned from medical treatment in Dubai.
  5. Russian Election Uncertainty: Prime Minister Vladimir Putin’scoalition lost its majority in parliamentary elections that were criticized for fraud. The question is does the Russian populace want the strong armed leader to return to his position as president in the March 4 election. A shift in the center of power in Russia, viewed as unlikely as of now, could have impact on its dealings with the rest of the world, and has implications for energy, as Russia is the world’s largest oil producer.

“I’m bullish, but I’m just picking my spots, recognizing the wind is going shift a lot," says Birinyi. "It’s not going to be at my back the whole time, and I don’t want to make a strong assertive bet or position on the entire market. I want to recognize that there’s going to be stocks, like the number one stock Apple , that doesn’t care who wins the election in Russia.”

Citigroup chief U.S. equity strategist Tobias Levkovich said the market is always pricing in some level of geopolitical risk, and right now it’s also pricing in negative U.S. corporate earnings growth.

“Geopolitical risk is always in place. We’re not really aware of it at the moment,” he said, blaming data overload. He has been watching the situation in Iran and says that North Korea is another area to watch, but for now the market is not focused on them.

“Your risk premiums are pretty substantial if they flare up,” he said.

Of the worrisome situations around the world, analysts see Europe as the number one focus for now, followed closely by worries about China, but they also put the tensions around Iran high on the list. Oil markets are sensitive to developments on Iran, but many traders say there would be a much higher premium in oil if the market thought the situation was coming to a head.

This past year has been affected by a series of surprising, exogenous events, like the earthquake and tsunami in Japan, and the flooding in Thailand that dealt a blow to the supply chain of technology companies when factories were literally underwater.

There was the surprising Arab spring uprisings, which toppled governments in Tunisia and Egypt. It sparked the revolution in Libya, which cut the flow of oil and caused a temporary spike in oil prices. Unrest continues in Syria which has been sanctioned by other Arab nations for its handling of protests.

Then there’s Europe, which stressed world markets regularly with market-moving headlines on its leaders’ slow and uneven efforts to contain the sovereign debt crisis, forcing investors to focus on developments there with a heightened intensity.

On top of that, one of the biggest bubbling concerns is that China is stumbling and that it could have a hard landing from its period of high growth, taking the rest of the world with it.

“The Chinese situation for me is a very big deal,” said Barry Knapp, head of equity portfolio strategy at Barclays . Knapp said China has now rolled its growth target to 7.5 percent from 9 percent. He also said the reversal of portfolio flows may also be signaling something bigger is going on there.

“The other big emerging market issue for me is Eastern Europe,” he said, noting the Hungarian Central Bank this week raised rates to 7 percent to stop the decline in its currency. “For me, Eastern Europe is the real canary in the coal mine for European bank deleveraging. All those places don’t have really developed banking systems so if Europe cuts them out, it’s a big problem.”

Oil Tight Rope

Topping the geopolitical concerns that could significantly impact oil markets is the difficult situation with Iran. While hoping to harm it enough economically to stop its progress towards nuclear weapons, Western governments are balancing the potential impact on the price of oil.

A spike in oil–and gasoline prices–could have a swift negative impact on the fragile economic recovery and on a European economy on the brink of recession. In the U.S. gasoline prices spiked above $4 a gallon this past summer, immediately hurting the U.S. consumers’ ability to spend.

As gasoline prices eased up, so did consumer attitudes and spending improved along with sentiment.

Trevor Houser, director of energy and climate practice at the Rhodium Group, follows Iran closely and he says oil markets could be in for a choppy year.

“You have legislation the president will sign by the end of the year as part of the Defense Authorization Act that will impose sanctions on the Central Bank of Iran. There is a relatively tight timeline on the implementation,” he said. The sanctions are a change in strategy for the U.S. which has previously tried to discourage the long term investment in Iranian oil production, not target near term exports.

“The view is that while the investment sanctions have been effective on long term production that’s not sufficient given the time line for Iran’s nuclear program,” he said.

Meanwhile, Europeans are debating an Iranian oil embargo with a decision expected by the end of the month.

Houser said under the U.S. sanctions, if an entity is involved in processing oil payments with the Central Bank of Iran, it would be precluded from doing business with the U.S. financial system. He also said there is some flexibility in the bill which would allow for the president to make the decision based on input from the Department of Energy on the oil market.

“We think that it has a potential to be meaningful in terms of impact,” he said. “The problem with this is it’s all opaque political risk. How exactly are the sanctions going to be implemented and on what time frame?”

“People are going to be trying to read the tea leaves…and it will make for a choppy year” (in the oil market), he said.

Follow Patti Domm on Twitter: @pattidomm