A Tour of European Politics

US midterms and their aftermath have hogged most American political coverage since November’s contest, but they are hardly the only show in town. From Brexit to yellow vests and everything in between, European politics have been churning. While markets have been rocky lately, as we look forward, we think European political gridlock and the potential for more falling uncertainty are underappreciated positives. For more details, read on!

President Macron, les Gilets Jaunes et les Taxes^[i]

Until last month, the phrase “yellow jacket” mostly referred to wasps with yellow and black stripes. But in recent weeks, it took on a new meaning, as French citizens wearing yellow vests launched high-profile protests against President Emmanuel Macron’s new fuel tax—a “green” policy aimed at curbing carbon emissions by encouraging folks to drive less. This aim did not go down well with the many people who live in France’s suburbs or countryside and rely on their cars for work. Macron’s offhand comment that they could simply wait for more fuel-efficient cars went over about as well as why don’t they just eat cake?^[ii] and had basically the same effect: demonstrations. Not necessarily over flippant comments, but over the perception that Macron had cut taxes for the wealthy while making ordinary working folks foot the bill.

We generally stay above the fray on topics like this, which are pure sociology, but there are some economic and stock market implications—and not just because France’s central bank warned the demonstrations could knock Q4 GDP growth a bit. Recent opinion polls show Macron is even less popular than France’s past two, very unpopular, presidents at this point in their terms: Macron’s approval rating is just 26%, compared to 48% for François Hollande and 29% for Nicolas Sarkozy. If he is like every other politician on Earth, his goal is to win re-election, which likely requires some compromise. After suspending the fuel tax hike last week didn’t win protestors over, it looked like that compromise might entail reinstating France’s wealth tax—repealed by Macron last year and replaced with a narrower levy applying only to real estate, not financial assets. In the end, however, Macron opted for a national TV address in which he apologized and offered a minimum wage hike and pension tax cuts. Which … didn’t much mollify protestors but did spark fears of rising French deficits and a budget battle with Brussels. Many suspect the EU would have to be as strict with France as it has been with Italy, lest it appear to have a double standard.

And so the beat goes on. Mostly, we see this as business as usual in the EU—politicking, jawboning and the odd compromise. For French stocks, however, it isn’t clear whether Macron still has the political capital to push through other economic reforms on his to-do list after last year’s tax cuts. That may disappoint those hoping for a sea change in French economic policy under his leadership, but gridlock does reduce legislative uncertainty, which we think should be just fine for markets. In the meantime, though, don’t freak out if French economic data released in the next couple months look a little wobbly due to lost output during the demonstrations.

Speaking of Italy’s Budget Battle …

Don’t look now (or hold your breath or whatever colloquialism works best here), but it looks like Italy’s government is closing in on a budget compromise with Brussels. Italy’s initial proposal contained a 2.4% deficit-to-GDP ratio in 2019, which EU officials believed could balloon too close to their 3% limit for comfort—especially since Italy’s debt is well above the EU’s 60% of GDP limit already. So they rejected it, sending Italian yields higher and Italian leaders back to the drawing board. For the next couple months, yields bounced around as Italy’s government waffled between appearing to compromise and vowing never to. But according to Italy’s La Repubblica, a compromise is now close at hand, with EU leaders willing to accept a deficit of 1.95% and Italian Finance Minister Giovanni Tria ready to offer 2.0%. A five-basis point gap is much easier to bridge than the last gulf between the two.

None of this really changes our opinion on Italian or eurozone stocks. Italian debt fears ignored how much Italy’s public finances improved in recent years, bringing debt service costs to generational lows. But reaching a compromise could help reduce Italian uncertainty, especially with many fearing the budget standoff would cause a recession there. So though not an economic game-changer, a budget blessing could be a tonic for sentiment.

Mini-Merkel?

German Chancellor Angela Merkel’s Christian Democratic Union (CDU) party picked a new leader last week, selecting Annegret Kramp-Karrenbauer—or AKK, to her fans—to succeed Merkel. This capped a tough campaign between her and Friedrich Merz, which exposed some divisions in the CDU. AKK, Merkel’s preferred successor, is a pro-EU centrist in the Merkel mode, earning her the nickname Mini-Merkel in some corners. Merz, however, was aligned with former Finance Minister Wolfgang Schäuble and presented himself as a vanguard against the center-right party’s perceived leftward lurch and a chance to reclaim voters who abandoned the CDU for the populist Alternative for Germany. He also has a much more tense relationship with Merkel, who sidelined him from party leadership in 2004. Hence, if he had won, there was a chance she wouldn’t remain in office until her term’s scheduled end in 2021—he could have forced her out and served out the rest of her term, which is usually what happens when party leadership changes in a parliamentary democracy. AKK, however, is much likelier to hang out while Merkel stays in office, which means her victory should extend the status quo. Stocks like a known quantity.

Stocks also like gridlock, which goes hand-in-hand with a lame-duck leader. With AKK likely spending the next couple years cementing her party leadership, she is unlikely to push for major legislation. Neither is Merkel, who is trying to hold together a tenuous coalition with the center-left Social Democrats and the CDU’s Bavarian sister party, the Christian Social Union. Both parties are going through leadership changes of their own, which likely compounds gridlock. Hence, German stocks shouldn’t have to face high legislative uncertainty.

More Populists in Spain

Gridlock is also the name of the game in Spain, where a far-right populist party called Vox unexpectedly took 12 seats in Andalusia’s legislature this month. Andalusia is a traditional stronghold for Prime Minister Pedro Sánchez’s Socialist Workers’ Party (PSOE), but Vox’s ascendance left the PSOE and its left-leaning allies short of a majority—a setback for Sánchez in his first electoral test since taking over for Mariano Rajoy this summer.

Before the Andalusian election, Sánchez was delaying the 2019 budget, presuming it would fail to pass and hinting strongly that he would call a snap election next year. He currently heads a minority government, and the PSOE holds just 84 of the lower house’s 350 seats. Recent opinion polls put PSOE ahead of Rajoy’s Popular Party, potentially leading Sánchez to believe a snap election could strengthen his hand and give him a majority coalition government. But that chatter has died down, and Sánchez’s cabinet now plans to unveil the budget in January and seems optimistic that the Andalusian outcome will prompt the Catalans to support it. Time will tell if this is a correct assessment, but for the time being, it does look like Spanish political uncertainty is easing a bit.

Checking In on Sweden

Three months after Sweden’s general election returned a hung parliament, the country still doesn’t have a new government. Prime Minister Stefan Löfven remains caretaker leader, but coalition negotiations are at square one. First, he and his cabinet lost a confidence vote on September 25. Then, parliament rejected the Alliance, a center-right coalition. So Löfven got another chance to try to form a government, and he got pretty close to a centrist coalition with the Centre and Liberal parties. But on Monday, the Centre party walked after Löfven refused to agree to add income tax cuts and labor market reforms to the coalition’s agenda.

Sweden’s electoral laws mandate that if parliament rejects four would-be prime ministers, it triggers a new election. So far, they have two strikes, as this latest coalition attempt never made it to the confidence vote stage. Löfven and others remain optimistic that some centrist grouping will eventually emerge and keep the populist Sweden Democrats on the fringes. But in the meantime, as negotiations continue, it looks like a watered-down budget is the only major bill with a snowball’s chance of passing for the foreseeable future. So Scandinavia joins Europe’s gridlock party.