The risk of a “reversal of European integration” has emerged as a concern for global financial markets this year, with wide-reaching trade and travel implications, says State Street Global Advisors.
In a new update titled Our Top 10 'Gray Swans' for 2016, State Street Global Advisors (SSGA) detailed 10 possible “flare ups”, marking a reversal of European integration as a risk for global markets.
“In 2016, the European project is facing severe headwinds,” SSGA senior portfolio manager, Investment Solutions Group, Lorne Johnson said.
“The year may end with fewer member states or new restrictions on trade and travel.”
A reversal of EU integration is significant. Mr Johnson pointed out that the EU now includes 28 member states with more than 500 million inhabitants. Trade barriers and cross-border travel have also been removed and 19 EU members use a common currency.
Mr Johnson said the 2015 terror attacks in Paris and the ongoing refugee crisis have “strained” relations within the European Union and the broader Schengen Agreement.
“As tensions mount and negotiations drag on over the fate of the million-plus refugees who have arrived since early 2015, nationalistic parties that have peddled Europhobia (and xenophobia) for years have been gaining real traction.”
Mr Johnson said the greatest risk for the EU remains the possibility of a British exit, or Brexit.
“If a Brexit did occur, a big if, pro-EU forces foresee serious economic shockwaves across the UK and beyond.”
Geopolitical risk is not confined to the EU. Escalating cross-border Sunni-Shia conflict between Iran and Saudi Arabia is an additional concern, according to SSGA.
“With Saudi-US ties frayed over the Iran nuclear deal, and with post-sanctions Iran asserting itself more forcefully, Saudi Arabia has taken the lead as the most militant Sunni power in the region,” Mr Johnson said.
With significant tension evident across the region, hostilities could worsen in 2016.
“An all-out war between the Sunni and Shiite-led countries remains a possibility, albeit a remote one," Mr Johnson said.
Due to expectations of heightened volatility throughout 2016, SSGA argued that investors need to review the downside protection they have in their portfolios.
"This can take the form of strategies with built-in rebalancing triggers tied to volatility, or managed volatility strategies that use either a rules-based or alpha-seeking active management to systematically tilt portfolios toward lower-beta holdings, among other approaches.”