Why We Think Spain’s Radical New Coalition Should Buoy Markets

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

326 days. That is how long it has been since Spain’s last government collapsed. Two elections and a lot of horse trading later, they finally have a new one: a minority coalition between Prime Minister Pedro Sánchez’s center-left Socialist Party and the leftist populist Podemos. On the bright side, this eases a year of political uncertainty, but investors aren’t cheering. Rather, pundits are dissecting the ruling parties’ campaign pledges and fearing the worst for Spanish stocks—especially banks, which have struggled lately. Yet given the coalition is likely powerless to accomplish much, we think reality should prove much better than feared, helping Spanish bank stocks improve.

It isn’t hard to see why investors are nervous, as the incoming government has made some rather radical pledges. In addition to partially rolling back prior governments’ labor market and pension reforms—undertaken during the eurozone sovereign debt crisis—they have proposed jacking up income and capital gains taxes, setting minimum corporate tax rates (with higher minimum rates for banks and energy firms) and implementing a limited financial transactions tax and more.^[i] We suspect this has a lot to do with Spanish banks’ diverging fortunes from the rest of Europe this year, considering bank taxes have been in the Socialists’ manifestos for both elections. Since April 26—the market close before the indecisive April 28 election—Spanish banks have declined -8.5%. ^[ii] Meanwhile, French and Italian banks, are up 17.8% and 8.4%, respectively.^[iii]

Yet what matters from here is whether the government can get any of this passed. To us, it looks highly unlikely they come anywhere close to fulfilling this whole agenda. Even with their combined forces, the Socialists and Podemos don’t have a Parliamentary majority. They are taking power solely because a Catalan separatist party agreed to abstain from Tuesday’s investiture vote, letting the coalition win with a simple majority of votes cast (rather than a full majority of lawmakers). Even then, they won by all of two votes. Any government that has to go through so many machinations just to barely get seated won’t be able to do an awful lot. It isn’t even clear that they will have more staying power than the last couple governments, considering the role of the Catalan separatists. If tensions between the federal and state governments escalate again, the Catalans could easily pull the plug.

To us, this looks like a repeat of Portugal in 2015, when a leftist government including the Socialists, Communist, Green and Left Bloc parties took power. Investors then feared the same things they fear from Spain’s new administration: unwinding prior reforms, letting the deficit run away and creating an overall hostile environment for businesses. Instead, the opposite happened. The government met all its budget commitments and kept most of the crisis-era reforms intact. Portugal’s tiny markets wobbled for a few days after the leftist coalition took power on November 25, 2015. But there was little lasting influence. The MSCI Portugal finished 2015 up 5.1% while global markets fell -1.8% over this span.^[iv] By the time voters returned the coalition to power this past October, Portuguese stocks were up 37.9%, edging global markets’ 37.0%.^[v] We think investors are likely to get some similarly positive surprises from Spain’s government.

The easing political uncertainty should add another tailwind. As Exhibit 1 shows, Spanish stocks underperformed world and eurozone stocks by a significant margin last year, with headwinds mounting long before the leftist coalition looked likely. Spain started trailing in late January, as it became increasingly clear Sánchez wouldn’t be able to pass his budget, virtually guaranteeing his government would collapse. They got come respite after the year’s first snap election, in April, when it looked like a coalition might form, but the rally was short-lived as negotiations broke down. Things only got worse as politicians stumbled toward a second election whose results were as fragmented as April’s.

Exhibit 1: Spanish Stocks Didn’t Like Uncertainty.

Source: FactSet, as of 1/7/2019. MSCI Spain, World and European Economic and Monetary Union Index returns with net dividends, 12/31/2018 – 1/6/2020.

But now investors know what they are dealing with. People can finally set expectations. Positively for stocks, those expectations are low, setting the stage for a bullish cocktail of falling uncertainty and positive surprise, which we think should reward those who have patiently held Spanish stocks.