The art of campaigning is to promise a lot and to excite voters; to offer an alternative to one's rival and make it clear what it is the candidate will do differently and better; and to provide a compelling, uncompromising vision of where a country is going. The art of governing is to compromise visions and break promises while implementing policy that adheres to the realities and possibilities of a given political climate.
French voters elected Francois Hollande on Sunday over incumbent Nicolas Sarkozy. Pundits, markets, and pretty much anybody else paying attention had been expecting this result for weeks. The immediate response has been a mostly benign market and pundit hand-wringing over what this repudiation of German-backed austerity measures (as well as the Greek vote held the same day) means for the Euro zone and Europe in general. Even if everyone knew it was coming, the return of a Socialist to Elysée Palace for the first time in 17 years matters.
Hollande campaigned on the promise of a return to growth-based measures and an end to dead-end austerity. Among his notable campaign proposals were vows to renegotiate the EU treaty limiting debt and to tax millionaires at 75% of their incomes. Proposals like these fall somewhere between good, clean campaigning and old-fashioned demagoguery, depending on one's political point of view. This hard-line stance against the rich and the austere could either reopen Pandora's Box on the debt crisis, cause all the rich French to flee to London, or bring European's decision-making to a halt, if you believe the hand-wringing.
There are several reasons, however, to discount these fears and to feel relief and even hope over Hollande's election. They mostly rest on the truism stated above: campaigning is one thing, and governing is another.
As vocal as Hollande was about his proposals to renegotiate the treaty and raise taxes, he also will face several realities. Most formidable is Angela Merkel, the most powerful politician in Europe. The German Chancellor represents the strongest economy on the continent and one that is unwilling to foot huge growth plans or major changes to the treaty; Merkel faces election next year. She isn't seen as having a lot of room to move away from Germany's position against inflation, and a new President who has never held executive office isn't likely to be the one to push her, even if he is representing Germany's key European partner.
The further context of the election ought to put some restraint on Hollande's agenda. While he won comfortably, his was also the narrowest victory in a French presidential election since 1974. The mandate is hardly an overwhelming one. Sarkozy also discredited himself not only on economic issues but in his pandering to the right wing and anti-immigrant sentiments within the country, a move that ultimately backfired when the extreme-right National Front's leader Marine Le Pen won 18% of the first round vote and refused to endorse Sarkozy for the second round. The voters' repudiation was as much of "Sarko" as it was of austerity-based policies.
The proof of the muddied but urgent economic climate in the country comes in Hollande's full platform. There are the tax hikes and the vows to renegotiate the fiscal pact, but there is also a promise to lower taxes for small businesses and, more significantly, to balance the budget by 2017, one year after Sarkozy hoped to. Many will say he's planning to do this solely through taxing and spending, and many balanced budget targets have been promised only to be missed, but the fact that someone on the European left is already promising a mid-term target for a balanced budget signifies how much the conversation has shifted.
France doesn't have a huge amount of flexibility in internal issues. Government spending is already above the European norm - 56% of GDP vs. 49.4% for the Euro Zone, 49.1% for the broader EU, and 53.73% for France's 12-year average. France's general government gross debt is more average for the EU at 85.8% vs. Germany's 81.5%, the UK's, and the EU's 82.5% average. At the same time, growth remains anemically positive, with the France economy growing at an estimated 1.7% last year and unemployment staying around 10%. (All stats courtesy of Eurostat.)
These figures, the facts on the ground, and the sentiment in the Bundestag will keep Hollande from initiating a spending orgy. At the same time, his election is a sign that the conversation is shifting, moving away from torturous austerity and towards growth. This is a good thing.
All indications are that austerity is failing at every measure: solving budget deficits, restoring "market confidence", or reducing bond yields, all misses. Spending in the short-term to encourage growth while making mid-term plans to balance budgets and reduce debt as a portion of GDP becomes a more attractive idea when given the alternatives.
Hollande alone won't be able to convince Merkel, Germany, and the rest of the no-inflation crowd, but consider the case of Holland, i.e. the Netherlands. The country was a big supporter of strict budget limits and Germany's overall EU policy, right up until their government failed to push a budget meeting the requirements through and Prime Minister Mark Rutte resigned. In the end, the Netherlands managed to get a budget through, but the difficult process offered another telling sign that the Age of Austerity may be doomed.
Lastly, Greece had a scarily negative election result, with radicals on the left and right winning crucial support. If the parties involved can form a coalition, it would likely be an anti-austerity one; if they can't, we would have another election in June and cycle through all this again. Many see the possibility of Greece dropping out of the Euro as an increasingly likely one. That could cause a great deal of short term ruckus, but might be the most logical end to a crisis that has dragged on the continent for 2+ years now.
The upshot of all of this for investors? Over the near-term of the coming 6-12 months, there is likely to be a lot of turbulence in the European markets. Elections, the new French government, and any further developments in Greece are all possible sources of shocks, and that's without mentioning recent headliners like Spain, Italy, and Portugal.
While the markets responded positively on first take, they are likely to pitch and roll in an unpredictable manner over this period. In the long-run, once Hollande figures out how to align his campaigning to his governing realities, and once this shift towards growth instead of austerity takes hold in policy, Europe could see better results both in growth and budgetary terms, results that would carry over to the markets.
This year is going to see frequent sales on European-based companies who trade on Europe sentiment. A slow build of long positions in undervalued stocks (for example, see this SA article for French ideas) over this short-term period could pay off nicely over the 2-3 year time frame, especially with some dividend names. Frequent sales mean plenty of chances to buy, so there's no need to rush in.
U.S. companies with European exposure are also worth considering, though in a more careful way. There are plenty of companies, especially manufacturers, who are doing well already and have shifted their focus away from Europe. These companies are insulated from Europe's turmoil to a degree, and hence not as undervalued (think Caterpillar (NYSE:CAT)).
Retailers who sell to Europe have been discounted a great deal, but in so far as Europe is weighing on them, they may pick up in value towards the back-end of Europe's return to growth. So for stocks like Ford (NYSE:F) and General Motors (NYSE:GM) that have already been dinged for European struggles, the investor can afford to wait even longer to see signs that Europe is starting to move in the right direction again.
Sunday's elections, while not surprising, marked another incremental step away from austerity and towards growth. Francois Hollande's win and the no-winner election in Greece will matter for Europe's economy and companies with business on the continent. While those involved figure out how to match their governing to their campaigning, or in Greece's case whether to govern at all, there could be some bumps for the market. But in the long run, Europe will be taking a better road, good news for investors everywhere.