A Common Thread Between Germany and Ireland

Editors' Note: Our political analysis is intentionally non-partisan. We favor no political party or politician in any country and assess political developments solely for their potential market or economic impact.

So much for European politics getting boring after Brexit. First Irish voters gave republican nationalist Sinn Féin a popular vote win at Sunday’s general election, likely toppling the government led by current Taoiseach Leo Varadkhar. Then on Monday, a regional government kerfuffle climaxed with the resignation of Chancellor Angela Merkel’s successor, Annegret Kramp-Karrenbauer (aka AKK), from her post as Christian Democratic Union (CDU) party head. Pundits naturally harped on how the rise of fringe parties led to establishment figures’ downfall in both nations, and from a sociological standpoint, we can see why that is worth spilling some ink over. Yet investors’ reaction—including a large-ish drop in Irish stocks on Monday—seems rather overwrought to us. The likely result in both nations is gridlock and reduced legislative risk, which stocks generally like just fine.

We can see why Sinn Féin’s rise spurred headlines globally, for it isn’t just any nationalist party. It is widely considered the former political wing of the Irish Republican Army (IRA), and its longtime leader (until 2018) was detained in connection with several IRA crimes (though never formally charged). That is all sociology and painful history, but we think it is important context for understanding why the party’s strong showing touched a nerve. In the decades since 1998’s Good Friday Agreement, which cemented the peace deal between the republic and Northern Ireland, Sinn Féin retained its nationalist agenda but pivoted toward left-wing populism. As in much of Europe, Irish voters have increasingly soured on the two main parties, Fianna Faíl and Fine Gael, both of which lean center-right. Meanwhile, the collapse of the center-left Labour Party and Social Democrats created a void on that end of the spectrum, which Sinn Feín filled. Its calls for boosting public housing and increased social spending played well with voters still scarred by Ireland’s Celtic Tiger boom and bust, as well as the ensuing debt crisis and years of austerity.

Germany’s story also has some historical undertones, though the populist party in question is the right-leaning nationalist Alternative for Deutschland (AfD). Last year, it and the Left (a successor of East Germany’s Communist Party) took the top two spots in the state election in Thuringia. Both mainstream parties—Merkel’s center-right CDU and the center-left Social Democratic Party (SPD)—pledged not to work with AfD, in hopes of delegitimizing a party many in the establishment consider a dangerous echo of the country’s past. That led to months without a state government. But last week, when balloting for the state premier reached its third round, the requirement for the winning candidate to win an absolute majority fell by the wayside, opening a path for a candidate to win with a simple plurality. Instead of fielding their own candidate for the third time and risking a victory by the Left, AfD chose to vote for the centrist, pro-business Free Democrats’ candidate, Thomas Kemmerich. So did the CDU, sealing his victory. A public outcry followed. Many urged Kemmerich to disavow a victory “tainted” by AfD support and step down immediately, but he held on for three days before resigning. Meanwhile, a civil war erupted within the CDU over its decision to—at least by appearances—ally with AfD, leading to AKK’s resignation. Germany’s next Federal election is due between August and October 2021, and Merkel has said she won’t run, so AKK’s decision creates some big question marks.

From a sociological standpoint, there is much to say about both stories. But as ever when it comes to politics, our chief concern is these events’ potential market impact. It seems fair to say both could raise short-term uncertainty, perhaps giving local markets a few hiccups, as happened in Ireland Monday. But both also should extend gridlock for the foreseeable future, reducing the risk of new legislation creating winners and losers. That gives stocks one less thing to stew over and should be a modest tailwind.

Strip out the emotions surrounding Sinn Féin, and you have two center-right parties combining for 73 of 160 seats (according to the latest results), with Sinn Féin at 37 and a smattering of left-leaning parties and independents taking the rest. Fianna Faíl actually edged Sinn Féin by one seat despite the latter party's narrow popular vote win, so no party has a strong mandate. Fine Gael and Fianna Faíl seem unlikely to try to work together despite their mutual loathing of Sinn Féin, lest their coalition flounder and create space for the nationalists to do even better at the next election. That leaves a few alternate possibilities. Sinn Féin could try to ally with the other left-leaning parties, but this is easier said than done, as their agendas don’t overlap terribly well—not least of all because of the nationalist wrinkle. They could also try allying with Fine Gael (unlikely) or Fianna Faíl (a bit more likely, if they really want to return to power), creating a weak coalition government with almost no ideological overlap. Any way you slice it, Ireland looks pancaked into political gridlock. Whatever government emerges—from this election or a potential second vote—probably won’t be able to do much, helping markets get over the initial anxiety.

As for Germany, Merkel’s government isn’t going anywhere for the time being. Her coalition is already hamstrung by competing partisan interests and internal shuffles. The SPD chucked its leadership last year, and its new head is much more left-leaning and not inclined to play ball with Merkel. Now, with Merkel already serving as a lame duck, the CDU must go through similar growing pains. As a general rule, when parties in a coalition are busy getting their own houses in order, they aren’t passing major new laws. If a leadership change preoccupies the CDU for the foreseeable future, that likely leads to the Bundestag doing very little in Merkel’s twilight. Depending on who wins the CDU’s leadership eventually, it could have implications for the next Federal election, but that is a late-2021 issue and impossible to handicap now. Markets will deal with it when they deal with it.

Germany and Ireland are just the latest in a long string of European countries where ascendant outsider parties have gone mainstream, bringing gridlock. Spain now has its first coalition government since Franco after upstart parties on the left and right hollowed out support for the traditional bloc. Italy’s populist government collapsed last summer, a little more than a year after it took power, leaving a shaky coalition between the populist and center left. Sweden’s multi-party minority government, led by the center-right, came to power only because the communist Left Party abstained from voting, while threatening to kill any policy they disagree with. Belgium has been trying and failing to form a government for over a year. And and and. We imagine it is frustrating for voters, but for stocks, it means minimal chance of legislation disrupting property rights and the like. Or, said differently, it means the populists investors fear can’t do the things investors fear, bringing markets relief.