From BlackRock: Markets are anxious about upcoming European elections, but Richard Turnill explains why near-term political risks are probably overstated.
Markets are anxious about several upcoming European elections, all featuring anti-European Union (EU) or anti-euro parties. Last year proved upsets can happen, but we believe European near-term political risks are probably overstated.
The Netherlands holds elections next week, soon to be followed by France, and later Germany and Italy. We are most focused on the outcomes in France and Italy, where populist parties could potentially gain power. Government yields there are up sharply, as evident in the chart below, with spreads at some of the widest levels since the eurozone sovereign debt crisis.
Markets view France’s presidential vote as the next potential electoral shock. Populist candidate Marine Le Pen, who has flagged a referendum on EU membership and reintroducing the franc, appears poised to make it to the final round of the two-round voting system. Yet if she does, polls suggest she will likely lose, with a polling gap far wider than that seen ahead of the Brexit and U.S. election surprises. Even if Le Pen were to win, we believe she would have a hard time securing a majority in parliament, lowering the near-term risk of a eurozone breakup.
Italy’s shaky political outlook worries us more and should keep Italian bond spreads wider ahead of a likely late-2017 or first-half 2018 election. Italian populist and right-wing parties together garner about 45% support in a country where anti-euro sentiment is strong and majorities in parliament may be factious and fragile.
For now, we see upside for European stocks, albeit with volatility, as global reflation and stronger growth boost corporate earnings and some political jitters calm. We are neutral on European government bonds, as elections pose short-term downside risks, and we are growing more cautious on European credit. An easing of European political risk should result in higher yields globally, supporting our cautious stance on U.S. Treasuries. Read more market insights in my Weekly Commentary.
The iShares MSCI EMU Index ETF (BATS:EZU) was unchanged in premarket trading Tuesday. Year-to-date, EZU has gained 4.36%, versus a 6.34% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of BlackRock.