Elections in the UK, France and Germany have major implications for the European Project, for economic growth, and for market sentiment.
It has become a truism to say that Western markets today are hypersensitive to political events.
The UK’s referendum result last year pushed sterling to a 31-year low against the dollar, while Donald Trump’s election victory last November pushed the dollar to an 11-month peak and was quickly felt on the S&P 500: the ‘Trump rally’ had begun. The fall in sterling and Trump rally were both major factors in the performance of the FTSE 100 last year, as it gained 14.4% and achieved its longest run of closing highs in 20 years.
This year, politics has provided further momentum for markets. After the centrist ruling party came out clearly ahead in the Dutch election in March, European stocks closed at their highest since 2015.1 In mid-April, the accession of Emmanuel Macron and Marine Le Pen into the second round of the French presidential election pushed French stock markets to a nine-year high, taking the euro up with them. Again, it was the success of the market-friendly centrist candidate that buoyed investors.
Yet while many stock market investors were delighted, very few indeed had predicted all – or even most – of the above outcomes. The possibilities of a vote for Brexit, a vote for Trump and the rise of independent candidate Emmanuel Macron were all statistical outliers before the respective campaign seasons began. In retrospect, therefore, it is evident that there was only one effective way in which investors could be well-positioned. Put simply, they needed to have skin in the game.
It is a salutary lesson for those tempted to sit out major political events and reinvest in the aftermath. It is also timely. The next important date on the electoral calendar is the 7 May, the date of the second round of the French presidential election; then there is the UK general election on 8 June; the French parliamentary elections occur a few days later, on 11 and 18 June; and the German federal elections will close off the season on 24 September. Yet simply considering any of these in isolation risks missing the point – the connections between them are strong and significant, not least for Brexit.
The presidential run-off in France is unprecedented, since neither of the two mainstream parties is represented. Markets were relieved that Emmanuel Macron, a centrist and former government minister in the Socialist Party administration, did indeed reach the final round to face Marine Le Pen, the Eurosceptic who favours returning France to the franc and closing its borders to immigrants. Macron has undoubted electoral weaknesses, such as his stint in finance and his lack of a party machine.
Yet almost nobody expects him to lose. Marine Le Pen’s policies alienate most of the French electorate, beyond her natural bases in the east, and especially the north-east. Nate Silver, the statistician who successfully forecast the outcome in 49 of the 50 states in the 2008 US presidential election, has calculated that Le Pen needs an 18-point swing in her favour if she is to win. Yet both the Brexit and Trump campaigns required a mere 2% swing to confound expectations.2
Since Macron is a globalist, centrist and Europhile, he is the darling of the markets. Yet even if an unprecedented chain of events was to precipitate a Le Pen victory, she would face enormous constraints on her power. Since the French presidential term was cut from seven years to five, the office has lost some of its clout, as the sitting president knows too well. Moreover, she will lack a party machine to help her. Macron would face the same challenges.
The greatest challenge of all comes in the form of the legislative elections in June. The president enjoys oversight and sway over key areas but it is the prime minister who runs the country day to day, and the president must nominate the prime minister from the majority party in the French parliament. Thus ‘cohabitation’ is expected – a president and prime minister from different parties.
“The likely failure by Macron to obtain a majority in parliament would compromise his ability to carry out his reform agenda and would create political tensions within the government,” says Mark Stanley of Payden & Rygel. “We will monitor political developments in France very closely. In our view, the June elections in France look more consequential than the snap elections in the UK.”
Macron has been fulsome in his support for the European Project, calling Brexit a “crime” which will push the UK into “servitude”. Pier Carlo Padoan, former Italian finance minister, said a Macron presidency raises the likelihood of a united EU negotiating position and of “a clear Brexit without ambiguities”.
It is less clear whether Brexit negotiations or Labour weakness (or even Tory election spending questions) loomed larger in Theresa May’s decision to call a UK general election for 8 June. Economic considerations may also have figured; growth figures released for the first quarter show the economy already slowing significantly, a trend widely expected to continue over the course of 2017. The slowdown provides impetus for Theresa May to get the election behind her as quickly as possible.
If motivations remain murky, the outcome appears all but certain, even allowing for the usual polling error margins. A Conservative Party majority of well over 100 seats, the size currently forecast3, would neuter the strongly Eurosceptic wing of the party, as well as its Europhile wing. Clipped wings would, in this case, give May far more freedom to pursue negotiations unhindered, which may be why markets welcomed the news.
Yet if this year’s elections are all significant to Brexit, the German federal elections in September could yet prove the most consequential of the lot. Unlike in the US, UK and France, populism shows no signs of making much headway in a major German vote any time soon. Merkel had been a shoo-in for a fourth term, until Martin Schulz quit as president of the European Parliament and became leader of the SPD, the leading centre-left party. Merkel is a Europhile, but Schulz outdoes her – and he opposes an easy Brexit for the UK.
In response, Merkel has toughened her own rhetoric, saying in recent weeks that the UK must pay its exit bill, cannot have special arrangements, and cannot retain all its rights and privileges – she complained that some UK politicians continue to live in an “illusion” on this score. Across the major EU capitals, the mood music on Brexit appears to be increasingly consistent. Viewed in this light, the greatest test for Theresa May, David Davis and Boris Johnson lies not in the general election but in what follows.
Markets therefore face four major European votes in five months, with little pause in campaigning, followed by a busy year or more of Brexit negotiations. Comments and events will surely push stocks in different directions at different times, and it would be foolish to try to forecast their swings and roundabouts. Yet as the past year has illustrated, the greatest danger for investors in the months ahead lies not in external political events, but in their own behaviour. Instead of sitting out the market for a while or, worse still, trying to time their entrances and exits in different markets, investors would do better to ensure that their portfolio remains diversified, to hold their nerve, and to focus on the horizon.
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
Payden & Rygel is a fund manager for St. James’s Place.
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