Germany and the UK Take Europe's Political Spotlight

As the dust settled on Italy’s coalition government theatrics in recent days, two new political dust-ups took their place in the headlines. German Chancellor Angela Merkel and UK Prime Minister Theresa May are both fighting for their political survival this month, with their governments seemingly hanging by a thread. Some speculate both leaders could be out of a job within the next couple weeks. We won’t speculate on that potential outcome, as governments’ wheelings and dealings aren’t a market function. However, we do think it is worth noting that in both nations, these sagas are emblematic of political gridlock, which is generally positive for markets. The latest events might heighten uncertainty in the near term, but regardless of how they pan out, both nations likely continue to have governments with limited political capital, internal divisions and little chance of passing radical legislation. Overall and on average, we think stocks in both nations should benefit from this low legislative risk.

On the whole, we don’t find it terribly surprising that either leader is hanging by her fingernails. May heads up a minority government, and her Conservative Party is sharply divided between lawmakers for and against Brexit. The issue that threatens to topple her—an amendment to the EU Withdrawal Bill that could allow MPs to bind the government’s hands in Brexit talks—cut right to the heart of this internal split. Merkel, who heads a fractious coalition, is similarly confronting a long-simmering issue: migration. But the split isn’t between her Christian Democratic Union (CDU) and its coalition partner, the Social Democratic Party. Rather, it is between the CDU and its sister party, the Christian Social Union (CSU), which represents the center-right in Bavaria, and a disagreement over whether to start turning away some migrants at the border. This issue threatened to split the CDU/CSU alliance over the weekend, though Merkel and CSU leader Horst Seehofer bought some time Monday by agreeing to spend two weeks seeking a compromise. Meanwhile, May faces her next crucial parliamentary test on Wednesday.

While the political tensions in both countries are rather acute these days, they don’t represent big changes from the status quo. May hasn’t been able to pass much since emerging from last year’s snap election with no majority, and she has already been defeated on Brexit-related legislation. Merkel has been similarly hamstrung, both in her current government’s short, 100-day lifespan and its prior term, which ran from September 2013 – September 2017. If both leaders hang on, the current gridlock continues. If May were to lose her leadership position, she could be replaced by a new Conservative Party leader who faces the same challenges as her, extending the pre-existing gridlock while putting a new face to it. Meanwhile, if Seehofer pulls the CSU out of government, Merkel could try to win parliamentary backing for a minority government—more gridlock. Or, either (or both) nations could hold snap elections, which polls indicate would stand a high likelihood of producing hung parliaments—again, more gridlock.

So whatever happens in the next few weeks or months, both countries will likely have governments that can’t do much—just as they have. Sweeping changes to property rights, regulations, taxation and the like should remain highly unlikely, much to investors’ and business owners’ delight. Even the most well-intended changes can create winners and losers, and behavioral finance research shows people feel the pain of loss more than the joy of an equivalent gain. An active government can make people nervous that they will be the next to “lose,” which can delay risk-taking as they wait for clarity, potentially weighing on stock returns. A hamstrung government, however, can do the opposite, enabling people to take more risk without worrying the rules might change before they are able to reap the rewards.

Overall, the latest political theatrics don’t alter our outlook for either UK or German stocks. For one, despite this year’s volatility, we believe global stocks are still in a bull market—economic, political and sentiment drivers haven’t turned negative, and this isn’t the first time stocks have stumbled for a few months during this bull market. Plus, given how tenuous each government’s hold on power has been from the start, none of these events should represent a surprising change for markets. Stocks have known for months that these leaders are politically weak. As uncertainty falls from today’s lofty levels, that should help bring markets some relief. Perhaps this will be more visible in Germany, as the ongoing Brexit debate generates more of a sentiment overhang in the UK. But in both nations, we believe investors should eventually be able to refocus on growing economies and a ripe environment for corporate profits.