This year has been one of uncertainty, with Brexit, China and Donald Trump all causing unpredictability in markets over the course of 2016. 
While this year has been less volatile (9.46 per cent) than the previous 10 year average (14.27 per cent), the risks remain and Adrian Lowcock, investment director at Architas, outlines the biggest potential events that could impact markets next year.
So far this year the market has largely shrugged off the impacts of the Brexit vote and the Trump presidency.
The year started with concerns over whether China’s growth was beginning to slow and the worries caused partway through 2015 by the government’s decision to devalue the yuan.
Performance of index in 2016
Source: FE Analytics
As the above graph shows, markets fell 8.7 per cent in January and February on the back of this sentiment, but soon began to tick up again.
Lowcock says China remains the biggest question mark surrounding markets as we head into 2017: “I think the obvious threat that we know about it China – without a shadow of a doubt that has got to be high up on the agenda.”
He adds this is because “we just don’t get very much transparency about China. You just don’t know what the fundamental issues are, how structural they are and actually how much growth is being sustained so at some point it has to come to a head”.
While many have written about the issues surrounding China in recent weeks, Lowcock says it is by no means the only issue heading into next year.
“I don’t think the biggest threat is necessarily the one that you strongly suspect will come about,” he said – adding that, for example, Donald Trump is not of particular worry to markets heading into next year as investors know that he is going to be president, taking away some of the uncertainty.
“Perhaps the biggest threat that isn’t being fully recognised by the markets is the political landscape in Europe, which is separate to Brexit but obviously linked,” Lowcock said.
Looking ahead, next month there is a referendum in Italy to vote on elections structure, with many seeing this as an opportunity to vote against incumbent prime minister Matteo Renzi, who has recently said he will quit if he loses the vote.
This is followed next year by elections in France, Germany and Holland, which all have the potential to cause major upsets in continental Europe, one of 2016’s worst performing regions.
Performance of index in 2016
Source: FE Analytics
As the above graph shows, the region has underperformed the MSCI AC World average by 13.54 percentage points so far this year and Lowcock highlights the area again as one that could struggle in 2017.
“You’ve got referendums in Italy on 4 December and you’ve got political elections in Germany, France and Holland next year, all of which have got the potential to have a surprise result.”
He says given the reaction of the media and large institutions to the Brexit vote, any ‘surprise’ results could be damaging for Europe, which may not be pricing any shocks in.
“When 52 per cent of the population voted to leave the UK and 45 per cent voted for Trump, there are plenty of people voting but the mainstream institutions, not just the media, were not willing to recognise it,” he said.
“The big risk in Europe is it is consistently underestimating the extent to which people want change, whether that change is Trump-like or Marie La Pen-like it doesn’t really matter.
“The Italian referendum is probably a small risk, the French one could be the big one because I don’t think Hollande is particularly popular.
“Marie La Pen is extreme even by what’s happened so far and would transform the landscape in Europe. To get a mainland revolt against the EU changes the whole outlook for Europe.”
Somewhat unsurprisingly, Brexit remains a key issue heading into next year, with the triggering of Article 50 widely expected to take place by the end of March – as Theresa May has promised.
“So far the EU seems to be navigating the Brexit relatively calmly, everyone seems to be thinking ‘it’s going to happen so just accept it’,” Lowcock said.
“The issue here everyone tells us it’s going to happen but that doesn’t mean we believe it and I think it is a risk that actually hasn’t been fully factored into the markets across the UK and Europe.”
The UK market has been one of the worst performers this year, but has responded strongly to a 5.6 per cent fall following the Brexit vote.
Performance of index in 2016
Source: FE Analytics
The FTSE 100 is 12.75 per cent higher in 2016 following a strong rally over the summer months, but Lowcock says this shows the market is not pricing in a hard Brexit.
“The thing with the Brexit negotiations is even when Article 50 is triggered you do not leave in two years’ time, you can negotiate everything and actually it is nobody’s interest to do anything other than carry on as things are.
“You’re going to have a lot of volatility in the market but with the challenge that has to go through the government and the potential for politicians to scupper it could lead to a lot of uncertainty in the UK.”
The final risk, though unlikely, is the potential of recession in the US and Germany.
According to Lowcock, every time there has been a two-term presidency, the US market has fallen into a recession during the next president’s adminstration.
While he admits this is not caused by the election itself stimulus within it can cause these downturns.
“It’s one of those pointless stats that doesn’t necessarily mean anything or create anything but I guess the big question mark hanging over the US is how long can this bull market go,” he added.
Performance of indices over 5yrs
Source: FE Analytics
The S&P 500 has outperformed the MSCI AC World by 50.33 percentage points over the last five years, as it has experienced a prolonged period of slow growth.
“I think the risk is that the US market does just fall off a cliff and have a recession – I think it’s a very unlikely event but I think the impact of such an event would be significant on markets,” Lowcock said.
Meanwhile, in Germany, he says the economy is ticking along very slowly, with latest figures showing GDP growth of 0.2 per cent.
“A German recession is something that’s hovering there as a potential risk because its 0.2 per cent GDP growth – it doesn’t take much to get that figure down or up. That could swing either way and lead to a contraction in Germany.”
However, overall Lowcock says it is the issues that come from ‘left field’ that will have the biggest effect on markets, with potential currency volatility as well as a return of the issues in Greece also possible in 2017.