Status quo or Ancien Régime?

European Elections 2017

Status quo or Ancien Régime?

When French far-right and anti-euro candidate Marine Le Pen drives more news stories than US and European central bank governors Janet Yellen and Mario Draghi, one can only conclude that political uncertainty is on the up. It has indeed become one of investors’ main concerns, especially ahead of this year’s three national elections in core European countries: the Netherlands, France and Germany.

Since thousands of young Spaniards camped in Madrid in 2012 to protest against the establishment, the populism movement has only increased in size and become global. Last year, anti-establishment leaders started to gain crucial votes, mainly the US election and the UK’s referendum to leave the European Union (EU). Non-traditional political candidates are becoming more popular, threatening the status quo and making political risk become one of the biggest concerns of investors. This is now especially acute in Europe, which faces three national elections over the next few months in the Netherlands, France and Germany, all EU founding members. The three elections include anti-euro candidates who, if victorious, could seriously challenge the European project and destabilise financial markets.


New regime?

The rise of populism has been brewing for years, especially since the 2007-2008 financial crises destroyed billions of dollars in wealth, left thousands unemployed and governments with piles of debt. Despite central banks’ efforts to flood the market with monetary stimulus, most developed market governments, especially in Europe, closed the taps and imposed domestic fiscal restrains to keep their deficits in check. Popular discontent increased, and so did income inequality.


Income distribution inequality has increased over the past decade... (measured by the Gini coefficient, where 0 represents equal distribution, and 100, perfect inequality)

Source: Bloomberg as of 9 March 2017. The Gini coefficient measures the extent to which the distribution of income among individuals or households within an economy deviates from a perfectly equal distribution. popular discontent has pushed up political uncertainty idices:

Source: Bloomberg as of 6 March 2017. The index used is the GLobal Economic Policy Uncertainty Index with Current Price Gross Domestic Product Weights, from Baker, Bloom & Davis. Please find definitions in the disclaimer.


Voters also were disillusioned with globalisation, one of the forces that had increased corporate profits since the 1990s, bringing wealth to some, and leaving others behind. But by the time protestors occupied Wall Street in 2011, globalisation was already in retreat: the cost cuts that multinationals enjoyed when producing abroad reached some limits, and some Emerging Markets (EMs) improved their technology and knowledge, narrowing the gap with the richer nations. EM salaries rose in key manufacturing locations, such as China, making production abroad less attractive. Corporate profits stagnated, deepening domestic woes, especially right after the crisis.

Once-heralded global public figures, such as the elites schmoozing at the World Economic Forum in Davos, became vilified, while unconventional leaders became more popular – for example, US president Donald Trump or French nationalist Le Pen. Britain voted to exit the EU in mid-2016 and political uncertainty rose to unprecedented heights. Political risk is now especially prevalent in Europe, especially ahead of the 3 elections.

What are the chances of a major disruption in each country? Let's look at the first one:



Election date: March 15

Candidates:  The Party for Freedom (PVV) is an economically liberal, anti-immigration and anti-European advocate, led by Geert Wilders. It is mostly contended by the People’s Party for Freedom and Democracy (VVD), a centre right, economically liberal, pro-European group. The Christian Democratic Appeal (CDA), the Green Left (GL) and the Labour Party (PvDA) are more minor contenders.

What are the key issues? Healthcare and pension reform, apart from housing and immigration.

What are the polls saying? In early March, the PVV led polls with expectations of 28 seats won at the Tweede Kamer (Parliament), a jump from the 15 it gained in 2012. Wilders’ party is closely followed by the VVD, with 27 expected seats, a sharp drop from its current 41.

Expected outcome: Since a majority government can’t be formed with anybody short of 45 seats, a coalition government is expected, with as many as four or five parties involved. This is slightly more than usual, given the increased number of populist and single-issue parties. The PVV may not be involved in such a coalition as other parties have expressed reluctance to make an alliance with them, given their more radical, anti-European stance. A VVD-led government is the most expected outcome – so, same as now.

 How has the market reacted? Dutch spreads over benchmark German bunds reached euro-crisis heights, although they have recently abated as polls showed that the expected number of PVV’s seats in Parliament had fallen from 36 in early February to 28 in early March. The leading Dutch AEX stock index has gained 4.34% so far this year (as of March 7), more than the STOXX Europe 600 index, up 3.17% over the same period.




What are markets saying?

Financial markets, however, are painting a rosier picture, based on a reflation idea that started last year, when China unveiled a monetary stimulus to avoid an economic hard landing. The world’s second-largest economy has been able to maintain growth at above 6.5%, annualised, at the same time that a manufacturing crisis in the US has abated. The US central bank says it is ready to continue hiking rates, a sign that the economy is heating up. Finally, Europe and Japan also seem to be waking up after years of dormant growth. 

So, are markets wrong or is the increase in political uncertainty overstating real risks? Or both? Click here for the opinion of Western Asset's Andrew Belshaw.

As it is often the case, uncertainty seems the only certainty. But some investors believe that chances of a fast and sharp global growth rebound remain slim: Europe needs to go through three national elections and Britain’s departure from the EU; US markets have priced in a successful outcome of policies that still may take more than a year to come into effect; Japan, while improving, is far from full traction, and China is heavily overleveraged.

Investors also worry that while the issues that have caused the popular discontent aren’t resolved, political uncertainty won’t abate. Populist candidates may not emerge victorious in this year’s European elections – but what about the next round in a few years’ time?


What can investors do?

Against this backdrop, picking the right asset class, country, sector or issuer will be crucial for performance. In order to maximise opportunities, investors with a flexible approach will be able to have a bigger selection of assets, without the constrains of traditional benchmark indices. These are normally skewed towards long-only, developed market, highly leveraged issuers, in the case of fixed income, or towards the largest companies, in equities.

Bond and equity markets are much bigger than that:  they also include Emerging Markets, smaller or lower rated companies, bank or infrastructure loans, derivatives, inflation-linked or asset backed securities, all in either developed market or Emerging Market currencies. A flexible manager can also use long or short strategies to profit in both up and down markets.

Experience and knowledge has helped active asset managers weather numerous wars and crisis throughout history. 2017 appears challenging, but also because of this, full of opportunity.


IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.