EU Election: Negative But Could Have Been Worse

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Includes: ACWI, ADRU, DBEU, DBEZ, DEUR, DEZU, DGBP, DRR, EEA, EPV, ERO, EUFL, EUFN, EUFX, EUO, EURL, EWG, EWI, EWQ, EWU, EZU, FEP, FEU, FEUZ, FEZ, FIEE, FXB, FXE, GBB, GSEU, HEDJ, HEZU, HFXE, IEUR, IEV, PTEU, RFEU, UEUR, UGBP, ULE, UPV, URR, VGK
by: David Kotok
Summary

The two leading parties, Chancellor Angela Merkel's Christian Democratic Union (CDU) and the Social Democratic Party, which are coalition partners, together got 44.7% of the vote, a significant drop from their 55.4% in Germany's 2017 federal election.

Marine Le Pen's far-right, anti-migrant, Euroskeptic National Rally Party (RN), at 23.3% of the vote, very narrowly defeated President Emmanuel Macron's La République en Marche! party (LREM), which gained 22.4%.

Italy was one country in which a strident anti-immigrant, anti-EU party, League (Formerly Northern League), led by Matteo Salvini, surged to a significant victory with 34.3% of the vote.

The weekend voting in the UK demonstrated the already evident sharp political division in the country totally dominated by the issue of Brexit, with some voters wishing strongly that the UK would leave the EU and others equally adamant that the UK remain, and with no apparent prospect for compromise.

By Bill Witherell, Ph.D.

The results of the European Union's Parliamentary elections, held the last weekend in May, were welcomed by investors as being not as bad as many had feared. A broad populist and nationalist anti-EU surge, which had looked possible, was avoided. Pro-EU lawmakers will continue to be in a clear majority, aided by gains by green and liberal parties, offsetting losses by centrist parties. The resulting fragmented make-up of the EU Parliament over the next five years suggests decision-making will be more complex despite the continued significant popular support for the European Union. A more concerning aspect of the election results is the view we get of national political trends in some European countries - in particular, Germany, France, Italy, and the United Kingdom

Germany: The two leading parties, Chancellor Angela Merkel's Christian Democratic Union (CDU) and the Social Democratic Party, which are coalition partners, together got 44.7% of the vote, a significant drop from their 55.4% in Germany's 2017 federal election. This was their worst combined result since the Second World War. The Greens' vote share was 20.5%, more than double their 8.9% result in 2017. A welcome development was the poor showing of the nationalist Alternative for Germany. These results suggest difficult times ahead for the ruling coalition, which is failing to connect with young people. Angela Merkel appears determined to remain as chancellor until October 2021, as her chosen successor, Annegret Kramp-Karrenbauer, the new leader of the CDU, is having a difficult time preparing to fill Merkel's shoes. The Social Democrats' poor performance has raised questions about whether they should remain in the coalition.

France: Marine Le Pen's far-right, anti-migrant, Euroskeptic National Rally Party (RN), at 23.3% of the vote, very narrowly defeated President Emmanuel Macron's La République en Marche! party (LREM), which gained 22.4%. This follows the turbulence of the "yellow vest" demonstrations over the past six months, which have led Macron to make a number of concessions to the populists. The Greens did well, coming in at third place with 13.5%. As the Greens are pro-European, they can be expected to work with the LREM and the Liberals in the European Parliament. The former leading French parties, the Socialists and the Republicans, each gained less than 10% of the vote. The opposition of the RN is not expected to cause Macron to alter his reform plans for France going forward. He also will continue to lead reform efforts in the EU.

Italy: Italy was one country in which a strident anti-immigrant, anti-EU party, League (Formerly Northern League), led by Matteo Salvini, surged to a significant victory with 34.3% of the vote. Its coalition partner, the populist anti-establishment Five Star Movement, slipped to third place with only 17%, behind the center-left Democratic Party's 22.7%. Salvani is now the leader of Italy's political right and is already making evident his intention to have a dominant influence over the policies pursued by the coalition. He is challenging the EU Commission with respect to the EC's government debt-limit rules, pressing for tax cuts despite Italy's already excessive debt and the prospect that the EC might respond with a significant fine. He also is proposing that the European Central Bank guarantee government bonds. The bond market is understandably responding negatively to this developing confrontation, which risks having effects beyond Italy.

United Kingdom: The weekend voting in the UK demonstrated the already evident sharp political division in the country totally dominated by the issue of Brexit, with some voters wishing strongly that the UK would leave the EU and others equally adamant that the UK remain, and with no apparent prospect for compromise. As a result, the ruling Conservative Party, the Tories, is in tatters, relegated to a fifth-place finish with only 8.7% of the vote. Nigel Farage's new one-issue, hard-line, anti-EU Brexit Party surged to a 31.7% victory. Championing the anti-Brexit "remain" position, the Liberal Democrats captured second place with 18.5% of the vote. Labour was third with 14.1%, and the Greens were fourth with 11.1%. Last week Prime Minister Teresa May announced she will resign on June 7th.

The campaign for a new Tory leader looks likely to result in a prime minister who will proclaim a hard-Brexit position. The Labour Party will probably move into a more pro-EU, "remain" position despite the anti-EU views of its leader, Jeremy Corbyn. There is a very limited prospect that a compromise deal will be agreed by Parliament and the EU in the coming months. The probability that a second referendum on Brexit will be held appears now to be greater than 50%, but time is running out for that option to be feasible. The risk of a hard, no-deal Brexit on the October 31 deadline has greatly increased.

Market Response: The European elections occurred at a time when the European economies are experiencing very weak growth, stagnant demand, and business optimism that has fallen to a four-and-one-half-month low, according to HIS Markit. The "less bad than feared" election results provided an immediate boost to equities that was reversed when European stocks followed global stocks down midweek, as trade war fears intensified, dropping almost 2.5% during the week.

Year-to-date as of May 31, European stocks have managed to hold on to moderate gains, close to the 9.2% gain of the global market as measured by the iShares MSCI ACWI ETF (NASDAQ:ACWI). The iShares MSCI Eurozone ETF (NYSE:EZU), has gained 8.2% year-to-date, and the iShares MSCI United Kingdom ETF (NYSEARCA:EWU), has gained 8.0%. France continues to do a little better, with the iShares MSCI France ETF (NYSEARCA:EWQ), up 9.4%. Italy has done worse, particularly since the elections. The iShares MSCI Italy ETF (NYSEARCA:EWI), has a year-to-date gain of 7.2%. German stocks continue to underperform, with the iShares German ETF (NYSEARCA:EWG), gaining only 6.2%. With the political turmoil across much of Europe and the increased risk of serious trade disturbances, these gains may be difficult to maintain through the rest of the year.

Sources: Financial Times, Wall Street Journal, CNBC.com, HIS Markit, Action Economics, Brown Brothers Harriman.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.