How Populists, Despite Fears, Can Boost European Stocks This Year

Buckle up! This week, voters in EU member-states will select the next European Parliament, and—predictably—populist parties’ ascent in the polls is fueling fears. While no one expects populists to control Parliament lock, stock and barrel, the prospect of populist groups getting more clout in the chamber has raised fears of discord and roadblocks toward further EU reform and integration. Cut through the noise, however, and we think the picture looks far better. As in individual nations, populists’ rise at the EU level likely pancakes the European Parliament further into gridlock, reducing legislative risk and extending the long history of positive post-election stock returns in Continental Europe.

To see how populists’ rise brings gridlock, it is important to understand how European Parliament parties work. “Parties” in Parliament are broad groupings of national political parties with overlapping ideologies. The European People’s Party (EPP), the main center-right party, includes German Chancellor Angela Merkel’s Christian Democratic Union, Italy’s Forza Italia and Spain’s Popular Party. Yet it also includes Hungary’s euroskeptic, populist Fidesz, whose policies clash with much of the EPP’s mainstream. The Progressive Alliance of Socialists and Democrats (S&D), the main center-left party, includes Germany’s Social Democratic Party, which is in Germany’s ruling coalition, as well as France’s Socialist Party and Italy’s Democratic Party. The Alliance of Liberals and Democrats for Europe (ALDE), a centrist grouping, includes French President Emmanuel Macron’s En Marche, The Netherlands’ Democrats 66 and Spain’s Ciudadanos. The other main grouping founded by traditional centrist parties is Alliance of Conservatives and Reformists in Europe (ACRE). It was started by former UK Prime Minister David Cameron in 2009 and still includes the UK’s Conservative Party, as well as Poland’s ruling Law and Justice Party, which is more populist than centrist. 

Then there are the outsiders, including the two main “populist” coalitions. One populist group is The European Freedom & Direct Democracy Party (EFDD), which was formed in February by Luigi Di Maio, Italy’s Deputy Prime Minister and head of the anti-establishment Five-Star Movement. It includes the UK’s new Brexit Party, headed by former UKIP maestro Nigel Farage. Euroskepticism aside, members have little ideological common ground. The other populist group is the European Alliance of People and Nations (EAPN), which includes Italy’s League, France’s National Rally (formerly National Front) and other far-right parties like Alternative for Germany, Finland’s Finns Party and the Danish People’s Party. Rounding out the pack are The Greens/European Free Alliance (Greens-EFA) and the European United Left/Nordic Green Left (GUE/NGL).

With centrist parties slipping in recent polls, some fear this creates an opening for more extreme groups to gain influence. 

Exhibit 1: Declining Support for Centrist is Sparking Fears

Source: Politico, as of 5/17/2019.

Yet even with populists gaining ground, the most likely outcome appears to be a centrist-led coalition. Polls peg the EPP, S&D and ALDE at a combined majority, and a three-way tie-up isn’t hard to envision. Less likely, though still within the realm of possibility, S&D and ALDE could bring in the greens and leftists, echoing some of the fragmented left-leaning coalitions around Europe. Or the EPP, ALDE and ACRE could try to build out a right-leaning government. However things shake out, it should bring gridlock. By definition, a grand coalition that includes three parties will have more internal disagreements than one that includes two—to say nothing of the aforementioned differences within the EPP. ALDE and S&D aren’t exactly uniform within, either. Similarly, would a right- or left-leaning hodgepodge of three, four or more groups have a uniform policy agenda? Or would it look more like the loosely cobbled together coalitions in the Netherlands and Sweden? The Dutch government, seated nearly two years ago, has done little. Even if a populist group ends up in the coalition, their influence likely won’t stretch beyond shouting.   

Far from a market risk, populists’ potential gains in the European Parliament looks to us like another example of populists “pancaking” European politics. Historically, the European Parliament—like national legislatures across Europe—was stacked in the center, with just a smattering of support for fringe parties. Their political spectrums looked like bell curves. Populists’ ascent moved support from the center to the edges of the curve, flattening the pancake. As this happened, more and more European nations got fragmented coalitions (the Netherlands, Sweden, Denmark) or minority governments (the UK, Spain). With this came more gridlock. Even in Italy, where populists took power, gridlock won the day as the coalition of far-right and left-ish anti-establishment folks lapsed into disagreement. With more gridlock comes less legislative risk, bringing more clarity to businesses and reducing investors’ uncertainty. At a time when EU institutions are grappling with major issues like corporate taxes, Tech regulation and other potentially disruptive endeavors, gridlock is likely even more of a blessing.

In our view, the high likelihood of gridlock tees up this election to follow the historical trend of rising uncertainty before the contest, followed by relief thereafter. As Exhibit 2 shows, continental European stock returns are consistently more positive after the vote than before it, with higher average returns. The one outlier is 2014, when the ECB’s wrongheaded negative interest rates and quantitative easing kicked in months after the election, outweighing political tailwinds. This time around, with fears higher heading into the election and QE on the way out, we think European stocks should enjoy plenty of tailwinds in the months ahead.

Exhibit 2: MSCI Europe Ex. UK Returns Pre & Post Election

Source: FactSet, as of 3/19/2019. MSCI Europe Ex. UK Index return with net dividends. “% positive” is the frequency of positive returns for the periods depicted.