Four countries, four sets of elections, same result: Anyone but the incumbents. Over the last few days, voters in Germany, France, Greece and Italy have delivered a clear message to politicians: Austerity has taken its toll. While the results certainly imply more near-term uncertainty, particularly in Greece, they also offer the possibility of a more balanced approach to the European quagmire.
Germany: While France and Greece grabbed the lion’s share of headlines, the most significant vote may have been in Germany. While not a national election, losses by Chancellor Merkel’s Christian Democrats and her coalition partner, the Free Democrats, in the northern state of Schleswig-Holstein offer the possibility that the German leader may be tempted to switch coalition partners before next year’s general election. If last Sunday’s losses are repeated this week in the far larger state of North-Rhine Westphalia, this could signify an eventual realignment of German politics. Should this occur, and Ms. Merkel’s center-right party enter into a marriage of convenience with the center-left Social Democrats, Germany may eventually acquiesce to a more growth-oriented European agenda, and we may see the eventual adoption of some type of aggregation of European debt such as Eurobonds.
France: As expected Francois Hollande, the Socialist candidate, defeated the incumbent Nicolas Sarkozy, and became France’s first Socialist President in 17 years. By all indications, this was more of a no-confidence vote on the stagnation and disappointment of the Sarkozy years than a ringing endorsement of Mr. Hollande or the Socialist platform. While the market is understandably nervous given some of Mr. Hollande’s more extravagant campaign promises - including lowering the retirement age and massive state hiring - I believe the reality of a Hollande presidency will be less dramatic than his campaign rhetoric suggests. Because France will be constrained by both the bond market and Germany, Mr. Hollande’s actual policies are likely to be more moderate than advertised.
Greece: In contrast to the above two elections, Greece’s election was unambiguously bad news as it raises the likelihood of more instability and potential political chaos. The two mainstream political parties garnered only about a third of the vote, leaving them dependent on smaller fringe parties in order to form a coalition government. Given voter anger, a fragmented political system, and the painful reality of long-term austerity, whatever government is formed is unlikely to be long-lived. This raises the prospect for more political uncertainty in Greece and growing friction between the country and the European institutions on which it has become dependent.
Italy: In Italy, early indications from local elections, in which around 9.5 million Italians are eligible to vote, are showing reduced turnout and anti-establishment, anti-European sentiment. While Mario Monti has stated that he is not going to run for office in the 2013 national elections, the parties that have supported his technocratic government’s austerity measures are likely to be more sensitive to voter anger and discontent.
For investors, the take away from these elections is that Europe is likely to continue to be a source of volatility in the near term. In particular, the complete fragmentation of the Greek political system does not augur well for that country’s stability, or for its ability to implement on the necessary structural reforms. As such, in the near term, we would continue to remain underweight Italian and Spanish equities. Longer term, the elections in France and Germany may represent a small step closer to a consensus that is likely to emphasize pro-growth policies in addition to the typical Germany mantra of austerity.