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  • European elections look priced in for now, but we see risk of localised storms

European elections look priced in for now, but we see risk of localised storms

  • European elections may increase political fragmentation and have repercussions for country politics
  • Eurozone equity valuations discount political risk, but secular stagnation fears prevent outperformance vs US
  • We remain neutral Italian bonds despite attractive spreads and have a small overweight in Eurozone equities
  • Hansvanzwol
    Hans van Zwol
    Between May 23 and May 26, Europeans will head to the ballot box to elect a new European Parliament. While normally we would not expect these elections to be of major market importance, NN Investment Partners has identified several concerns that are worth keeping an eye on.

    First, the projected rise of populist parties could create a more fragmented parliament. We are concerned about the weighting of pro-integration parties versus Eurosceptics, and increased fragmentation may complicate the nomination of the new president of the European Commission. This may influence the way international investors look at Europe. The political balancing act in the nomination of key positions is also important, whereby a balance has to be found between small and large countries and between northern and southern Europe. This will affect the nomination of the next ECB president in October, an element to which markets may be more sensitive.

    The European election will also affect national politics, especially in Italy. If the League (the junior party in the country’s current coalition) emerges victorious in the European elections, it could aim for early national elections in autumn and hope to become the senior partner in a right-wing cabinet. Finally, the UK will send 73 members to the European Parliament until Brexit is dealt with, and they could also influence the selection of key positions.

    European sovereign bonds outlook

    We don’t expect the election results to significantly affect Eurozone government bond yields and the direction of Europe. Even if the populists gain 30% of seats, as recent polls have predicted, traditional parties should still be able to form a workable majority. Moreover, markets have already discounted a gain for populist parties. Volatility and risk aversion have recently risen, but we attribute this more to the US-China trade conflict. The market impact of political events is generally short-lived, with relatively little influence on the direction of markets.

    The impact might be different for individual countries, especially Italy. A possible government reshuffle or even new elections makes markets nervous. The Italian spread over Germany has risen 40 bps, which also stems from the recent risk-off environment. There are good reasons to be cautious about Italian debt but markets could react positively on new elections, as a right-wing or centre-right coalition is seen as more market-friendly than M5S.

    Figure 1: Italian, Spanish government bond spreads vs Germany (%)

    Source: Thomson Reuters Datastream, NN Investment Partners

    Hans van Zwol, Senior Portfolio Manager Global Fixed Income: “Although current bond spreads look attractive (10yrs Italy is currently trading around 280 bps over Germany), we remain neutral Italian bonds. And given that sharp moves in Italian spreads could affect other countries, we stay neutral country spreads. The best example is Spain, which we find fundamentally attractive at current levels, but where we stay neutral simply because of the contagion risks.”

    European equity outlook

    Patrick Moonen
    We have a small overweight in Eurozone equities, for three reasons. First, we see low investor positioning, based on both surveys and institutional flows and positioning data. However, inflows are picking up and willingness to allocate towards the region seems to be increasing. Second, earnings momentum has bounced from its prior lows and is on a rising trend, unlike in Japan or emerging markets. Third, the market seems to be largely discounting political risks. The relative price to 12-month forward earnings and the additional equity risk premium are at levels we haven’t witnessed since the European debt crisis.

    Figure 2: Eurozone equities are attractively priced


    Source: Thomson Reuters Datastream

    Patrick Moonen, Principal Strategist Multi Asset: “The biggest hurdle preventing the Eurozone from outperforming the US is the low interest-rate environment keeping the financial sector from outperforming. Secular stagnation fears are mounting, which means investors will require a higher risk premium, as they already do for Japan. Low nominal growth is also a factor that keeps bond yields low. Finally, this weighs on relative earnings growth, which largely explains the Eurozone’s long-term underperformance relative to the US. Investors prefer to invest where growth is most likely, which is currently the US. We have a small overweight in US equities.”