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The content of this post does not constitute financial advice. It is intended for information and education purposes only.

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No one likes negative surprises when it comes to their money. But right now, the world is not exactly in its calmest state, and the rest of 2024 will likely not be much different. That can present an opportunity for savvy investors who know how and when to take advantage of the big changes happening around them. But political turmoil, rearrangement of global economic ties, policy changes, and related market swings can also test individual investors and their portfolios, sometimes to the extreme. Let us talk about what to watch out for as this year progresses.

As the first month of 2024 showed us, even with inflation receding globally and central banks considering normalizing their policies, economic troubles still persist in many countries. China, the world’s second-largest economy, is in the midst of real estate turmoil and needs to resort to additional measures to stem the outflow of capital and the plunge in its stock market. Germany, Europe’s manufacturing engine and largest economy, is still struggling to recover from its industrial decline, construction recession, and the global fall in demand for exported goods and services. The US is growing strongly but its internal political polarization spells out a turbulent election year ahead, while its regional banks which have been experiencing a rather challenging period since March last year, are now reminding us once again that the risks in the financial system are far from gone. The risks that every individual investor needs to be aware of, are multifaceted and complex, as their diverse nature holds a range of factors driving significant uncertainties around the world. Let us look at some of the major ones.

Geopolitical turbulence and domestic political divisions

2024 is a year that will set a record for elections, as they will be taking place in 50 countries, including in the biggest economies: the United States, the European Union, India, South Korea, Mexico, and most likely also the United Kingdom, among others. Some incumbent governments will likely be punished by the electorate for the past couple of years of high inflation and the hit to the living standards and real wages. According to surveys by major banks and consulting companies, this is one of the top, if not the top risk, when it comes to economic and money matters (including for fund and portfolio managers).

Elections in multiple countries are likely to be marked by growing political, societal, and ideological divisions, which could lead to local escalations. But even more importantly, they will most probably impact foreign and domestic policies, including economic policy. Issues like the support for foreign countries in conflicts have been a contentious subject in regions like the US and Europe, and the outcome of the elections could lead to major changes in the size of financial and military aid, as well as direct involvement. This has the potential to cause significant negative impacts on global supply chains, shipping routes, and government budgets, which would in turn put at risk the recovery from the inflationary shocks of the past couple of years and could drive energy prices back up.

In some countries, the loss of trust in the existing institutions or political parties and leaders can be damaging to the economies and can cause social and financial upheaval. In addition to that, growing economic fragmentation, as the West attempts to ‘de-risk’ from China and disengage from Russia, can result in market volatility and further loss of purchasing power or essential supplies in places that have highly concentrated exposure and global interconnectedness. As international trade can be particularly vulnerable to such developments, countries like Germany which have material import and export dependencies would be hit hard.

How to factor that in for your investment portfolio? Break down and understand what risk factors (currencies, countries, asset classes, macro variables such as interest rates, inflation, credit growth, etc.) you are exposed to. For example, do you hold instruments that are particularly sensitive to disruptions in supply chains, access to resources, or the US imposing tariffs on the EU and China? Or do you have a concentration in a certain region that is likely to become a scene of a military confrontation? Is currency exchange rate volatility a major concern for your portfolio? If that is the case, think about how such risks could affect the operations and profits of companies/sectors you are invested in, their creditworthiness, or the government’s ability to repay its debts or to protect itself against aggression. Try not to panic and do not become a victim of the crowd mentality—severe market shocks are usually temporary.

It is useful to remember that different markets can react differently to geopolitical shocks, and those reactions can often be unpredictable (see below an example from Joachim Klement of the impacts on different stock markets). In addition to that, the impacts on some markets can be short-lived. For instance, an ECB study from 2023 shows that geopolitical conflicts (such as 9/11, the Russian invasion of Ukraine, or the Israel-Palestine conflict) can lead to an adverse short-term response in oil prices. But after the initial spike that can last several weeks in many cases, the elasticities generally become insignificant after one quarter for most countries as concerns start to fade out, and prices start to come down. On other occasions, however, they could last much longer depending on the duration of the conflicts or the country-specific factors at play.

Risks of more policy errors

I will probably not surprise anyone if I say that economists are split on whether the major central banks have overtightened or not. But this can be said on almost any type of economic policy or issue. There is also no agreement as to whether fiscal consolidation and austerity are the right way to address an economic slowdown or an increase in government borrowing and spending. This year, monetary and fiscal policymakers will try very hard to convince us that they made the right decisions, adjusted rates and other policy tools to just the right extent, and that helped achieve their goals: disinflation, growth, employment, etc. So you will hear some reassuring statements like “the economy is strong”, “the labor market is resilient”, “the financial system is stable and well-capitalized”, etc.

The problem is that we are likely just beginning to see the lagged effects of policy decisions made in the past 18–24 months. Corporate debts are about to be rolled over more intensely in the next couple of years, defaults are persistently on the rise, and high-yield credit spreads have not yet reflected the increase in credit risk visible in the interest coverage ratios and other metrics. Central banks like the ECB, the Fed, and the BoE are trying very hard to find the right balance between the need to keep rates higher for longer in an effort to reduce inflation, and their hope to avoid a severe recession or a major crash in their financial systems. Therefore, a lot hinges on the next couple of quarters and the right timing of rate cuts and other potentially stimulative measures. Cutting too soon could lead to a resurgence in inflation, and holding high for too long could be destructive to some sectors of the economy. Many have already made that argument for the Euro Area, as the ECB might have overtightened considering the supply shock that caused this inflationary episode and the stagnation/contraction inflicted on key sectors in the biggest countries (Germany, France, Italy).

Markets in the US, the UK, and Europe have started pricing in policy rate cuts starting from March. However, central bank governors are desperately trying to dissuade them from this ‘over-eagerness’, explaining that such expectations are too aggressive and unrealistic. But are they? For example, in the US, we saw last week the regional bank issue returning with vengeance. New York Community Bancorp (NYCB) announced a 10-times increase in its loan-loss provisions related to real estate, which caused the stock price to plunge 38%. Other banks exposed to the distressed commercial real estate (CRE) markets in the US or elsewhere in the world have also been hit with significant increases in their provisions. US small banks in particular have a much higher degree of exposure to CRE compared to large credit institutions, which puts them at enormous risk as the sector has been hit hard by the increase in interest rates and the shift to remote and hybrid work. A broader instability in the financial sector is perhaps the thing that could force the Fed’s (or other central banks’) hand.

As David Rosenberg notes, whether there is no rate cut and that leads to recession, or a cut that leads to acceleration of inflation, the ‘Goldilocks’ conditions are running out of time. Because, as the market begins to reprice, the ‘regime-change assets in the hard asset universe’ are the ones that will be in the first line to benefit from the new market conditions. In addition to that, the potential for rate cuts makes fixed-income instruments in local currencies more appealing.

Slow recovery or further contraction

China was expected to roar back rather quickly from its pandemic lockdowns, but it would appear that structural forces and global fragmentation have kicked in instead to slow it down. Last year, the pace of recovery in retail sales, industrial output, and investment was disappointing, the economy went into a deflationary episode, and the real estate sector continued to be in turmoil. The stock market is still stubbornly falling and even the politburo admitted that there are some great difficulties facing the economy and that support measures are needed. The question remains whether in 2024 China can avoid a debt-deflationary spiral and whether private sector confidence can be restored given the hit to the property sector which constitutes a majority of household wealth.

The woes in China reverberate internationally — especially in Europe, whose export sectors need Chinese demands for global exports to pick up, while the manufacturing sectors need the imports of intermediate goods for production (e.g., machinery, vehicles, minerals, chemicals, etc.). These dependencies are hitting European industries, especially those in Germany, as shortages and drops in demand are impacting output. In addition to that, there was also a decline in China’s investments in Europe.

But Europe’s problems go beyond its reliance on the Asian economy. It still has not ensured its energy security and is forced to endure higher energy costs compared to before March 2022. Businesses in the service and construction sector are pointing to labor shortages and low demand, while consumer surveys and retail sales indicate that confidence is in the drain and cannot sustainably recover for over a year due to the inflation shock. The hope is that this might change in the next few quarters as inflation recedes, but in some countries, real wage growth has still barely turned positive. Without better sentiment, consumption will have a hard time picking up again, which is holding the economy back compared to other regions like the US. Demand for loans has also been hit severely, and loan rejection rates are still rising. Banks expect this trend to continue at least for another quarter or two.

Europe does have the potential to recover once rates start coming down (in the latest lending survey and interest rate statistics release, they seemed to have topped out) and salaries catch up to the accumulated inflation. A more meaningful industrial recovery, however, is a challenge, due to the productivity gap that has opened compared to the US and China.

In the US, growth has been surprisingly strong, driven by the consumer, and government spending (and in the latest quarter also by investment growth). Inflation has responded well to the Fed’s policy, as noted before, and now financial conditions are becoming looser again, so most economists are now confident that there will be no recession. However, leading indicators are still giving warning signals for some challenges ahead, and nonfarm payroll growth seems to be dominated by growth in part-time work, while full-time work declined, accompanied by a fall in hours worked. Housing affordability remains low, but activity in the residential sector is expected to recover in 2024. In contrast, the commercial real estate sector, as noted before, is a source of major concern due to both structural and cyclical factors. It can cause problems in the financial system.

The adverse effects of new technologies

In an international survey of risk managers performed by Allianz, technological risks, and in particular cyber risks, are on top of the list. Businesses around the world are worried about what kinds of disruptions or losses they might incur if cyber attacks would occur. Hackers could also utilize large language models powered by artificial intelligence to exploit data vulnerabilities, spread malware, and even disrupt critical infrastructure across the world. This could have serious consequences on business operations and crucial public services, for example, and can cause major market swings. That is why investors need to be aware of and pay attention to such possibilities.

AI-powered models and systems, as well as other technologies, are also being used to influence political outcomes, front-run market events, and affect trading. We already have an idea of what automated high-frequency trading could lead to in terms of market impact. The US Financial Stability Oversight Council recently named AI as one of the key risks to the financial system in its annual report. In addition to the benefits of its use, FSOC refers to the ‘safety-and-soundness risks like cyber and model risks’ related to the broader use of AI in financial services.

While new technologies are certainly on the radar, investors should also be concerned about technologically lagging industries and regions. For instance, there are countries and sectors in Europe (e.g., Germany), where the adoption of new tech has stalled and failed to catch up to others, reducing their competitiveness. As once globally leading giants have fallen behind in this new environment, they are losing markets — a case in point is German auto manufacturers. They have persistently failed to catch up to US and Chinese competitors when it comes to electric cars and infrastructure, which made them state that they have already lost the battle for this market.

CONCLUSION

Paying attention to the risks described above and the extended list in the attached image could be useful for individual investors in avoiding losses. Nobody can predict with certainty what domestic or global event(s) will be the biggest driver(s) of market volatility in 2024, but it is reasonable to assume that unexpected geopolitical and macroeconomic shocks, including those caused by supply chain disruptions and military conflicts, would have the biggest impact if they were to occur (or escalate further). Local elections could also lead to turbulence in some countries. These are also among the biggest concerns of professional money managers together with monetary and fiscal policy changes, the negative effects of technological advancements, and cyber risks. The best thing that a novice investor could do is keep track and monitor whether such events are likely to occur, and prepare a strategy in case that happens — in terms of protection, portfolio rebalancing, and — where possible — how to take advantage when profitable opportunities arise.