Issues like internal nationalist and independence movements, for example, the recent referendum in Catalonia, rarely impact financial markets as these internal regions and national groups have no markets of their own.
“These events tend to be transitory; even major geopolitical events tend to be quickly digested by the market,” said Wood. For example, the Greek crisis is nearly five years in the past, and the suffering of the Greek people continues, “but the capital consequences were only attendant to Greek debt and the potential for a Greek debt default.”
Inflation, Taxes, Deficits And Debt
McMillan is concerned that inflation could become an issue in 2018, but he doesn’t expect a sudden spike in inflation rates. Instead, he argues that low interest rates and investor complacency make financial markets more sensitive to mild increases in inflation.
Tax reform may end up blowing up the national debt, according to McMillan, with current proposals anticipated to cost up to $1 trillion in additional federal budget deficits over the next decade, increasing the national debt by up to 50 percent. As interest rates increase, more of the federal budget must go to servicing debt and taxes will have to be increased again, or spending will have to be “dramatically” cut.
“The deficit is not a headline issue today because the sequesters worked, lowering the deficit to a point where it was no longer trouncing the expansion of the tax base,” said McMillan. “Now, we’re seeing the deficit increase again, and if tax reform is passed, it will be that much worse,” but because Democrats are comfortable with deficit spending, and Republicans will have caused the deficits, McMillan does not expect the debt to become a campaign issue over the next election cycles.
However, any expectation for up to $1 trillion in new infrastructure funding should die with the passage of tax reform, said McMillan.
The next year is largely expected to be marked by growing market risks and declining investment returns.
“If we see inflation start to pick up, the market will start to have to get closer to where the Fed is at,” said Aliaga-Diaz. “That could result in more volatility. In the past, the Fed has started the year with a hawkish path and has had to change course to bring expectations back to where the market is. This year, the risk is that it goes the other way and the market follows the Fed.”
Low bond yields mean investors will continue to take risks to generate portfolio returns, said Vanguard.