At first blush, results of the European Parliamentary elections look good. The far-right populists did worse than expected, while the Greens picked up the slack. However, a more granular examination of the results suggest trouble ahead in Germany, France, Italy, and the UK, the four largest members of the EU. We view the election results as broadly negative for EUR and GBP.
Germany: Alternative for Germany (AfD) was founded in 2013 and is currently led by Alexander Gauland. In 2017 elections, AfD won 12.6% of the vote and 94 seats out of 709 total. It had never held seats in the Bundestag before, falling short of the 5% threshold in the 2013 elections. AfD came in third behind Merkel’s CDU/CSU, who won with 32.9% of the vote and 246 seats. Coalition partner SPD came in second with 20.5% and 153 seats. Fourth place went to FDP with 10.7% and 80 seats, followed by the Left with 9.2% and 69 seats and the Greens with 8.9% and 67 seats. Over the weekend, Merkel’s CDU/CSU bloc won with 28.9%, followed by the Greens with 20.5%. Coalition partner SPD came in third with 15.8%, followed by AfD with 11%, the Left with 5.5%, and FDP with 5.4%. Elections must be held by October 2021.
France: The National Front (FN) was founded by 1972 by Jean-Marie Le Pen and is currently led his daughter Marine. It was renamed National Rally (RN) after her loss to Macron in the second-round presidential election May 2017 by 66.1% to 33.9%. In the June 2017 parliamentary elections, FN came in last with 8 seats out of 577 total. Macron’s coalition came in first with 350 seats, followed by the center-right coalition with 136 seats and the center-left coalition with 45 seats. Over the weekend, Le Pen’s RN won with 23.3%, followed by Macron’s coalition with 22.4%. The Greens came in third with 13.5%, followed by the Republicans with 8.5%, France Insoumise with 6.3%, and the Socialist coalition with 6.2%. Elections must be held by June 2022.
Italy: The nation stands out for having separate anti-immigrant and populist parties that rule together. League (previously the Northern League, which advocated secession by northern Italy) is led by Salvini and has evolved into an anti-immigrant party while the Five Star Movement (M5S) is led by Di Maio and is considered populist. In the 2018 elections, M5S won with 32.7% of the vote and 227 seats out of 630 total while League came in second with 17.4% and 125 seats. The center-left Democratic Party came in third with 18.8% and 112 seats, followed by Berlusconi’s Forza Italy with 14% and 104 seats. Over the weekend, Salvini’s League won with 34.3%, followed by the Democratic Party with 22.7%. Di Maio’s M5S came in third with 17.1%, followed by Berlusconi’s Forza Italia with 8.8%, Brothers of Italy with 6.5%, and More Europe with 3.1%. Elections must be held by May 2023.
UK: The UK Independence Party (UKIP) was founded in 1991 and was led by Nigel Farage. Farage left to become leader of the new Brexit party. In 2017 elections, the Tories came in first with 42.4% of the vote and 317 seats out of 650 total, followed by Labour with 40% and 262 seats and the Scottish National Party with 3% and 35 seats. The Liberal Democrats were fourth with 7.4% and 12 seats, followed by the Democratic Unionist Party with 0.9% and 10 seats. Over the weekend, the Brexit party won with 31.7%, followed by the Liberal Democrats with 18.5%. Labour came in third with 14.1%, followed by the Greens with 11.1%, the Tories with 8.7%, UKIP with 3.6%, and SNP with 3.3%. Elections must be held by May 2022.
The makeup of the European Parliament itself has no direct implications for either fiscal or monetary policies. The former is determined by the national governments, while the latter is set by the ECB. Yes, the EU itself has a budget. However, at around $140 bln, the EU budget is smaller than the budgets of Austria or Belgium and makes up only 2% of the combined national budgets of all 28 members.
Instead, this weekend’s elections give some insight into the political trends coursing through Western Europe. From that, we can infer some potential investment themes. We believe the election results in Germany, France, Italy, and the UK are all very euro- and sterling-negative. French, Italian, and UK bonds are all likely to underperform Germany as a result. Our DM Equity Allocation Model suggests all four of these equity markets will underperform too. Let’s go down the list one by one.
Germany is facing heightened political uncertainty as Merkel heads into the sunset. Her chosen successor Annegret Kramp-Karrenbauer (AKK) is struggling to get traction for both herself and her CDU party. Press reports suggest Merkel is unhappy with AKK and is determined to stay on as Chancellor until her terms ends in October 2021. Having a lame duck Merkel at the helm of the de facto leading member of Europe couldn’t have come at a worse time for the struggling German economy or for a European Union that is struggling with its identity. Our DM Equity Allocation Model suggests a VERY UNDERWEIGHT position on German equities.
France saw the National Front come in first this weekend. With elections not due until June 2022, this risks Macron becoming a lame duck for an extended period. Macron has been rocked by the Yellow Vest movement this past year, forcing him to make many populist concessions on the economic front. We see risks that Macron goes further down this road in the hopes of reclaiming some support. Our DM Equity Allocation Model suggests an UNDERWEIGHT position on French equities.
Italian voters have rewarded Salvini for his increasingly strident populism. His League is now in the driver’s seat and we think it’s possible that fresh elections are called to capitalize on the current popularity. Regardless, Salvini is set to dominate the ruling coalition and push his anti-EU agenda. He has already said he will focus on cutting taxes even as reports suggest the European Commission may discipline the nation next week for its failure to limit its debt. Salvini is already taking a confrontational tone with regards to the possible penalties. Our DM Equity Allocation Model suggests a VERY UNDERWEIGHT position on Italian equities.
The UK is stumbling towards Brexit as divided as ever. The Tories and Labour were punished by the voters, which makes it unlikely that fresh elections will be called. We believe that the Tories will tack further in the direction of Brexit hardliners in the hopes of winning back voters that it lost to the Brexit party. With Boris Johnson leading the race to succeed May, we believe the risks of a hard Brexit are rising ahead of the October 31 deadline. Our DM Equity Allocation Model suggests an UNDERWEIGHT position on UK equities.