This article first appeared in the Telegraph.
Next week’s European Parliament elections aren’t on the same scale as the world’s biggest democratic exercise in India, but they are a significant event with upwards of 400 million voters in 28 countries due to elect 751 MEPs. Somewhat unexpectedly, at an estimated cost of £150m, we will be sending 73 of them from the UK, even if only for a matter of weeks before Brexit brings them home again.
Held every five years since 1979, this pan-European vote usually fails to hit many people’s radars, let alone those of investors. The average turnout over the past 40 years has been 52% and it’s been falling steadily since the outset. At the last election in 2014 just 43% of eligible voters bothered to take part. Although MEPs are responsible for signing off the EU’s €145bn budget, approving international treaties and trade deals and appointing the European Commission and ECB presidents, they do not set the political agenda nor propose legislation.
This year, however, there’s a chance that next week’s election might matter more than usual and even have a market impact. With every major European institution set to appoint new leadership this year, domestic politics in turmoil in several EU countries and resurgent populism expected to end the centrists’ grip on power in the European Parliament, this could be the first European vote of significance.
The rise of populist parties is the key change. They are either in, or support, ruling coalitions in no fewer than 11 of the 28 countries in the EU. While not all advocate exit from the EU, most share a desire to make the EU less ‘European’ and offer voters an alternative to the pro-European-project mainstream that has dominated for four decades. The scale of the populist insurgency is hard to predict because of the low historic turnout but all told it could be as high as 35% which would be enough to meaningfully disrupt EU policy-making on key issues like trade, immigration, single market regulation, energy and climate change.
The second key influence newly-empowered populists might have is on domestic policy-making. The results of next week’s vote could have an impact in Germany, where both the leading players in the coalition are struggling, France, where President Macron’s reforms are under mounting pressure, and, of course, in Britain.
The local government elections provided a foretaste of the kicking both main parties are likely to receive on the 23rd. Latest polls suggest the Brexit Party and UKIP will take 30% of the vote between them, more than Labour and twice the share of the Conservatives. Anti-Brexit parties in total might come close to matching the combined Leave vote. Less certain is whether this widely-expected result would have much influence on the parliamentary arithmetic of Brexit or hasten the departure of the Prime Minister. More likely, the vote will simply be viewed as a second referendum by proxy telling us what we already know - that we are split down the middle.
When it comes to the market reaction, investors will look to government bond markets for a judgement on whether the populists’ appetite for incontinent public spending will encourage a shift to more relaxed fiscal rules. The widening gap between Italian and German government bond yields after the Lega/Five Star victory provides the template here. But, in reality, the chance of populists having the political clout to actually deliver easier fiscal legislation is slim. Any changes on this front will be a slow burn.
The other potential area in which the elections might have an influence is in deciding who should replace Mario Draghi at the European Central Bank when he steps back later this year after eight years in which he never once raised interest rates. His accommodative approach has set a supportive tone for European markets since the financial crisis, but again significant change is unlikely, given the strict constraints within which the ECB operates. More than most central banks, Europe’s has a clearly defined mandate with an inflexible objective: headline inflation close to but below 2%. There’s not a lot of room for manoeuvre in a consensus-driven governing council over which the President has no veto. With inflation remaining subdued in Europe, the ECB will remain supportive.
So, the outlook for Europe’s stock markets will most likely continue to be driven by events outside the region quite as much as political developments within it. First and foremost, Europe is exposed to global trade so a resolution of the ongoing trade impasse between the US and China is key. There is a close link, albeit with a lag, between sentiment and economic activity in China and in Europe. The best thing that could happen to European companies would be an uptick in consumer spending in China on the back of recent stimulus.
That might see a reversal of the outflows from European investment funds, now at a 15-year high. Surveys of fund managers have not been so negative on European markets since the financial crisis, driving a shift in valuations to multi-decade extremes. Compared with global stocks, European shares have not been so cheap in 50 years while the gap between dividend yields on shares and the income offered by safe but stingy government bonds has not been wider in a century.
Political fragmentation and a growing inability to push forward a policy agenda is not necessarily a bad thing for investors. Hung parliaments and ineffective coalitions can leave companies alone to get on with what they do best, creating value for their shareholders. That’s especially the case in a region like Europe, with such an impressive array of world-class businesses. Perhaps a divided and ineffectual talking-shop in Brussels is just what investors should wish for.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.