Having spent some time with European Fund Managers there is the inevitable discussion about European politics and the risks for investors.
There are four key events facing Europe this year:
15 March – Netherlands Elections
31 March – UK triggers Article 50
7 May – French Presidential Elections
24 September – German General Elections
At present, there are two fears; firstly, in the Netherlands and secondly France. In both cases the opposition candidates are pushing for a referendum on the Eurozone and therefore, if the candidates are successful then the big question is what happens to Europe? This is something I have been grappling with for some time.
The more I talk to people, the more it appears that the political risk is being overstated; there has been 36 continuous monetary outflows by investors from European assets which suggests that they are nervous about investing and evidence on the ground is that many are holding back until they know the result of the French elections. Thus, returns, have been muted.
At the same time investors seem to be ignoring an improving macro picture; displaying earnings growth from European companies (many of which are global companies) and cheap valuations compared to the US.
If the economic story is positive and the markets are holding back, then the two things that could change things positively are, if all the so-called predictions are incorrect. So, the big question is what are the chances of Geert Wilders and Le Pen winning, and are some journalists and political analysts wrong?
Pick up a newspaper and there seems to be a growing feeling that Geert Wilders will win and the EU will implode. But for Geert Wilders to enact a referendum he will need a 2/3rds majority. It seems that this will not happen, and a more likely outcome will be a coalition government where Wilders is not involved.
If he does win, there is no evidence that he will win a referendum but like the UK, the risks are greater.
If we are wrong and Wilders sweeps to power, then it would appear to open the way for Le Pen to win in France. If this happens, we are being told that Le Pen will call a referendum and France will vote to leave the Eurozone.
What we are not being told is that there is a four-stage process before this can happen.
Firstly, Le Pen must finish in the top two of the first round of votes (this is likely to happen), secondly Le Pen has to win a majority in the second round (this is unlikely but could happen if there was a terrorist event in France or there is bad news about the second candidate).
If Le Pen gets through and becomes President, then any referendum has to be approved by parliament. This is stage 3; the Front National are the 9th largest party in France, so to get a majority government would be a miracle (somewhat like UKIP winning the next UK elections). If they got this far, then the referendum would go to the people and the evidence suggests there is greater support for the Eurozone than many journalists would lead you to believe.
Merkel vs Schulz
Turning to Germany it appears that AfD party are unlikely to win but the fight will be between CDU (Angela Merkel) and SPD (Martin Schulz). If Schulz wins he is likely to form an alliance with the Green Party. A Schulz victory is unlikely to impact the Eurozone, although it may make the UK’s negotiations harder with a less friendly Chancellor.
Many forget that Austria was expected to vote in a Fascist President last year and in the end the Independent Candidate (Alexander Van der Bellen) comfortably won with nearly 54% of the vote. We think this is important, and although we would never say never, it does appear that behind the headlines it is unlikely that Wilders will win in the Netherlands. If he does, he is unlikely to have the majority needed to call a referendum. Equally if Le Pen wins, she will fail to get the majority in the elections in June to call a referendum.
If these assumptions are correct, then investors are likely to reverse the outflows into Europe and money coming in will drive up share prices. A rally should occur on the back of positive macro data and improving earnings, as well as a realisation that the risk of political upset has been overstated.
We would add that upsets can happen as we saw in the UK and US, but these events were in fact easier to achieve. In Europe, the electoral system is such that it makes the likelihood of the same happening much harder, and this seems to have been missed by many journalists and political analysts who are predicting a shock in Europe.
Note: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.