2014 was filled with political risk, a concept referring to political changes that can affect the value of an investment. From Russia’s military adventurism in Ukraine to renewed US military involvement in the Middle East, headlines were filled with geopolitical turmoil. But despite all the potential political conflicts, the ones that ended up metastasizing only minimally affected most investors. Even Russia comprises well below 1% of the global stock market. Political conflicts that could have more dramatically affected financial markets—such as China’s territorial disputes in the South China Sea and Scotland’s independence referendum—mostly fizzled out without causing too much financial damage. That could change in 2015 as political risk in Europe intensifies.
The surge of political risk in Europe has been caused by the rise of radical political parties that are less favorable toward European integration. Their support has been bolstered by the continent’s slow economic growth, a backlash against so-called “austerity” policies to reduce governments’ budget deficits, and disagreements between countries with struggling economies (such as Greece and Spain) and countries with stronger economies (such as Germany) over who should bear the cost of boosting economic growth.
There are a number of countries where these parties could potentially take power. Polls in Greece suggest that the radical Syriza party could win in the country’s parliamentary elections later this month. The party has pledged to fight for better terms for Greece from its international creditors, which has led to fears that a Syriza victory could lead Greece to exit the euro zone.
Radical anti-establishment parties in other countries could also achieve success in elections this year, such as the Podemos party in Spain, the Danish People’s Party in Denmark, and the UK Independence Party in the United Kingdom. Financial markets face additional uncertainty in the UK election, where Prime Minister David Cameron (from the mainstream Conservative Party) has pledged to hold a nation-wide vote on whether the UK (which is not part of the euro zone) should remain as a member of the European Union.
With so much electoral uncertainty in Europe, and even uncertainty about whether the euro zone and European Union will stay intact over the next few years, managing political risk will be a difficult. But that doesn’t mean investors should abandon international markets, or even abandon Europe. The lesson from 2014, when some countries viewed as politically risky (such as Russia) suffered cratering stock markets while others (such as China) performed well, is that being well-diversified internationally can be a good way to handle political risk.