The S&P 500 hit a new peak last week, buoyed by US President Donald Trump’s address to Congress. At the same time, the US dollar was riding high as the futures market started pricing in the probability of a rate hike later this month at over 80%.
Global equity markets, meanwhile, continued to grind higher, despite the threat of rising interest rates in the US and increased talk of tapering for the ECB.
However, a major reason for our cautiousness on European equity markets is the uncertain political environment.
The first of these important elections takes place today, when voters in the Netherlands go to the polls. Many commentators see the Dutch election as a bellwether as to what might happen in the rest of Europe, particularly in the event of a victory by Geert Wilders, the extreme right-wing candidate who leads the PVV (or Party for Freedom).
Recent opinion polls suggest that he is in first or second position, running neck-and-neck with the right-wing liberal party (VVD), led by Prime Minister Mark Rutte. However, should Wilders win, many of the other main parties have ruled out the possibility of going into a coalition with him, so in that respect the election is wide open. But a Wilders victory would sound an ominous note for politicians and markets alike.
An ‘intriguing’ subplot to Brexit
In Britain, we should see the invocation of Article 50, the first step in leaving the European Union, by the end of March at the very latest. Britain then has two years to negotiate an exit deal. Key issues up for discussion include trade deals, outstanding debt obligations and the right of EU nationals to stay in the UK—and vice versa for UK nationals living in the EU. The tone of the Article 50 announcement, whether for a “hard” or “soft” Brexit, will be closely scrutinized, particularly by currency markets.
One intriguing subplot is the possibility of Nicola Sturgeon, leader of the Scottish National Party, demanding a second referendum on Scottish independence at the same time Article 50 is invoked. Should this happen, the political situation in Britain may become yet more uncertain.
Le Pen or the Sword?
Back in Continental Europe, we have the first round of the French elections on April 23. Last week, Republican candidate Francois Fillon shrugged off concerns about his candidacy and announced that he was still standing for election. However, the independent centre-left candidate, Emmanuel Macron, is way ahead of him.
And the right-wing nationalist candidate, Marine Le Pen, who is calling for the reintroduction of the French franc and has promised a referendum on France’s continued membership in the EU, is out in front of both of them—at least for the first round. None of the polls to date, however, indicate that she is likely to win the second, final round, which is more likely to go to Macron or Fillon.
But nothing’s certain in politics and this partly explains the precipitous fall in German bond yields over the last week or so as worried investors sought to hedge their bets.
Last Line of Defense?
Finally, in September we have the German election, which currently looks like a two-horse race between Angela Merkel, leader of the Christian Democrat party, and Martin Schulz, the Social Democrat party candidate.
At present, Merkel and Schulz are vying for poll position, with the lead switching between them, but the election is still months away and much could happen between now and then. It’s also worth noting that an Italian election may take place later this year, although no date has yet been specified.
What connects all these developments is the growth of populism, in Europe, the US and elsewhere. However, whether the forthcoming European elections prove to be a high-water mark for populism remains to be seen. Support for Germany’s right-wing Alternative for Germany party, for example, has fallen away recently.
And last year, Austria rejected the right-wing candidate, Norbert Hofer, in its presidential election.
Against this backdrop, it’s vital that investors remain focused on the fundamentals. Beyond the political noise, the economic data is steadily improving, not only in the US, but in Europe as well. Earnings look favourable, business confidence is improving and inflation is rising.
If, and it’s a big “if,” the various European elections have favourable outcomes, it would remove a major overhang in these markets and there could be a meaningful move higher in European equity markets.
Joe Amato is CIO of Equities at Neuberger Berman