At the moment elections and politics are in the mind of the investment community and investors alike. It is natural for all parties to have some concern about the impact of a change in government. In the UK it seems likely that we will see a big shift towards Labour but in Europe the shift is in the opposite direction.
Some 373 million voters from 27 EU countries voted in the European Parliamentary elections in early June. The result was a surge in support for right-leaning parties, while the backing for ruling parties languished.
WHAT HAPPENED AT THE EUROPEAN ELECTIONS?
Of the wider European parties the right leaning European People’s Party and Conservatives and Reformists made the largest strides, as Renew (centrist pro-EU) and the Greens lost the most support. Domestically, in France this resulted in Marine Le Pen’s National Rally winning the popular vote with around 31% – its best showing.
In Germany, Olaf Scholz’s SDP had the worst result in a national election in the party’s history. Furthermore, the wider German coalition may be under jeopardy as it only received circa 30% of the vote, with power shifting to the Christian Democratic Union of Germany (CDU) and Alternative for Germany (AFD).
WHAT ARE THE IMPLICATIONS?
This is a breaking down of the status quo of northern European politics. The leaders of European powerhouses, France and Germany, are simply becoming less influential as their associated parties lose votes.
In France the snap election is a big gamble and President Macron could be handing power to Marine Le Pen’s National Rally party.
Travel to the other side of Alsace-Lorraine and you find another uncertain coalition. Olaf’s Scholz SDP had their weakest national election result in the party’s history, and the coalition’s combined vote was only marginally larger than the CDU’s. The far right AFD also had their best result on record.
In the UK it appears that the Labour party will win by some margin. The financial markets are clearly assessing their credentials and their ability to be financially responsible and to date the market hasn’t reacted badly to that prospect.
WHAT ARE THE INVESTMENT IMPLICATIONS?
Uncertainty in German and French politics makes for a shaky situation, and markets reacted reflecting the uncertain backdrop of the political landscape.
The French equity market (CAC 40) fell by almost 10%1 and the spread of French over German government bonds hit a Euro-era high. Given the snap election announcement and result of the European Parliamentary elections, it is not surprising that French assets underperformed.
From an investment perspective, the risk to the large cap index is less than it may seem at the outset. LVMH, L’Oreal, Hermes, TotalEnergies and Schieder Electric are the top five companies by market cap listed in Paris, all of which operate with stable fundamentals and are backed by a globally diversified revenue base. In fact, this applies to the strong majority of the firms in the CAC 40.
WHAT DO INVESTMENT MANAGERS DO TO POSITION PORTFOLIOS AT TIMES LIKE THIS?
Fund managers do not try to predict the outcome of elections – after all they are not trying to bet your money as if they were in a Casino. 2016 reminded us that the consensus can be wrong. In 2016 who would have predicted Trump for US president over Hilary Clinton and who would have predicted a vote that saw the UK leave the EU? At the time both of these outcomes seemed highly unlikely.
What they can do is examine the underlying choices in the portfolio and decide if the companies held are going to withstand the political turmoil and potential change of government. For example, if we have a left wing or a right wing government will people still buy soap, petrol, food, eat out…clearly people will but the skillset required of an investment professional is assessing which companies will struggle in the new environment and which will thrive.
An investment management team will continue to assess their underlying holding to see which companies might be adversely impacted and ensure that changes are made to reflect these risks. If however they remain confident that the reasons for buying into a company remain valid then they will continue to hold that company to realise full value over time.
RISKS & RISK MITIGATION
Investors globally will continue to focus on the developments of northern European politics, especially the interplay of domestic and wider EU policy. The biggest risk on the table is the debt stability of France, and whether they transition into the sick man of Europe. A country with debt-to-GDP ratio of 110% has little margin for error, and a convincing National Rally victory may be looked at with extreme caution by global markets, with the resultant effect being a likely further increase in borrowing costs.
The main takeaway from an investment perspective in Northern Europe is that portfolio exposure to French government debt should remain low and should be primarily focused on UK and US government debt. Within equities, the majority of large cap French equities owned within our NBL portfolios are high quality names with global revenues such as LVMH and L’Oreal, which should help insulate them from domestic political vibrations.
SUMMARY
Political uncertainty is on the rise in Europe with the political tide turning in France and the foundations of German politics looking shakier by the day. Europe clearly lacks the leaders of yesteryear, such as the stable partnership of ‘Merkozy’ (the strong relationship between Angela Merkel and Nicholas Sarkozy).
The UK is perhaps a more familiar political landscape to us so we will all have a view of how things will play out. Liz Truss showed us that the international financial community has a significant say over some of our domestic politics especially when it comes to balancing the books and fiscal credibility. This is critical to being able to borrow money on international markets.
As ever, we are confident that we have a well selected balance of quality in the NBL investment portfolios and we continue to believe that, over time, patient investors will be rewarded despite the volatility that markets exhibit.
