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(Bloomberg) -- European equities are at records, vaccination rates are picking up and central banks are funneling trillions of dollars into the economy. But there is still plenty that could go wrong, with a resurgent coronavirus outbreak, another missed summer holiday season and elections keeping investors up at night.While the pandemic turned 2020 into a stock market roller-coaster, 2021 has begun on a more optimistic note. The Stoxx Europe 600 Index has jumped 9.6% this year and hit an all-time high in April, the VStoxx Index of euro-area volatility has calmed down close to pre-pandemic levels and, so far, there have been few major earnings season mishaps.Still, there are plenty of potential pitfalls.“We see 2021 as a year for equities, as recovery is set to turn to expansion,” said Cristina Rodriguez Iza, who oversees $42 billion as head of global multi-asset solutions at Santander Asset Management Spain. “Anything that derails that recovery could be a risk for equities.”Here’s what investors in European equities worry about the most:No Summer SunSetbacks to life getting back to normal are the biggest risks to the market rally, according to fund managers. The reopening is especially crucial to companies and economies that are dependent on travel and tourism. Europe’s Stoxx 600 Travel & Leisure Index has soared 24% this year on the hope that holidays will be possible over the summer.Any hiccups in the vaccine rollout could cause a setback for stocks such as discount airline EasyJet Plc and IAG SA, the owner of British Airways. The inoculation campaign is now speeding up after a slow start in continental Europe, but there’s been a spike in coronavirus cases after variants of the virus emerged such as those in India.“The greatest risk is that a mutation of the virus appears that is resistant to vaccines, because it would have devastating effects,” Enrique Marazuela, chief investment officer at BBVA Private Banking, said in emailed comments. “The increases in the stock markets have been based on the thesis that the pandemic will be eradicated before the end of 2021.”Election FeverPolitical hurdles closer to home can’t be ignored. In France, voters go to the polls for regional elections in June, foreshadowing the presidential vote at this time next year. Far-right leader Marine Le Pen has backed off from unpopular ideas like leaving the euro currency bloc, and her popularity is growing. Germany also holds a national election in September, with the Greens surging in opinion surveys.Anything that upends the established political order could cause at least short-term swings in stocks, with the risk of a more sustained decline if governments with less market-friendly policies are elected.“There is now an outside chance that it could be a Green-led coalition which might result in left-wing parties joining the Greens in power,” said Nick Edwards, manager of the Guinness European Equity Income Fund, referring to the German vote. “Meanwhile, if Marine Le Pen prevails in the French election next year, markets would recoil, but with Frexit and Eurexit already off the table, likely only temporarily.”Also on the radar: Scotland will hold elections next week that have put a fresh independence vote back in focus, and the resignation of Northern Ireland’s first minister risks triggering more instability around the implementation of Brexit.Back Down to EarthWhile some sectors struggled last year as economies across Europe locked down, the pandemic restrictions have been a boon to businesses such as online food delivery firms and payments companies.However, with investor expectations now high, there’s a risk that the momentum peters out for some of these lockdown winners. While earnings from meal-kit maker HelloFresh SE, food delivery firm Delivery Hero SE and online casino operator Evolution Gaming Group AB show they’re still enjoying a pandemic-related boost to growth, early cracks are appearing. Swedish mobile-messaging firm Sinch AB soared almost 370% in 2020 and was Europe’s top-performing stock, yet its shares slumped 11% Wednesday after earnings missed analyst expectations.“Companies have faced very easy comparisons year-on-year and have been able to post impressive growth numbers which will continue up to June, marking the nadir of 2020 earnings,” Richard Scrope, manager of the VT Tyndall Global Select Fund, said via email. “Going forward, growth will be harder, and we feel many companies have rallied ahead of their potential.”The Inflation QuestionRising inflation is another risk on investors’ watch lists, given the prospect of companies hiking prices when economies reopen as consumers go on a spending spree. And with commodity prices rising, firms could also see higher input costs.The worry for investors is also that, if the economy is running too hot, this could prompt central banks to scale back the pandemic support too soon. This is set to be a main topic at the European Central Bank’s next meeting in June and is also a focus for the U.S. Federal Reserve, especially if Treasury yields move higher on inflation bets.“A key risk to our outlook for Europe is insufficient fiscal support,” Grace Peters, EMEA head of investment strategy at J.P. Morgan Private Bank, said in emailed comments. “Any indication of a shift back towards austerity could introduce downside risks to growth, fears of a resurgence in political populism and a widening of the risk premium for European assets.”Here’s the TaxmanU.S. President Joe Biden’s tax hike proposals are front of mind for investors. Bank of America Corp.’s monthly survey in April found that tax increases are a growing worry for fund managers, cited as the biggest tail risk by 15% of respondents. The key concern among equity investors is that Biden’s plan can provoke pre-emptive selling, cut stock valuations and slow down the rally in tech shares.The Biden administration unveiled plans to pay for its $1.8 trillion spending plan with higher taxes, focused on the wealthiest Americans.On the Bright SideThere are certainly risks out there. That being said, they don’t form fund managers’ base-case scenario for European equities this year. Most see an economic recovery gathering pace, which stands to benefit the region, since it has a heavier weighting in cyclical sectors. European stocks also are cheaper compared with the U.S., the optimists say.Hugh Gimber, global market strategist at J.P. Morgan Asset Management, said that fund flow data shows how European stocks have often been overlooked in recent years, but the pieces are in place for that to change.“Vaccine rollout across the continent stumbled out of the blocks, but we are likely now past the point of peak pessimism,” Gimber said by email. “Our confidence around a substantial economic reopening over the summer months is increasing.”For more articles like this, please visit us at bloomberg.comSubscribe now to stay ahead with the most trusted business news source.©2021 Bloomberg L.P.
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