Europe Votes: Could More Countries Reject the EU?
- Upcoming votes in Europe could create market volatility, but resolving outstanding political uncertainty could be good for stocks and the economy.
- We believe there are arguments against another country voting to leave the EU within the next year.
- While some near term caution may be warranted, it’s not the time to abandon global diversification.
The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.
Could more voters to turn against the European Union? It's worth asking after political disaffection led to Britain's unexpected vote to leave the EU in June and pollsters failed to predict Donald Trump's victory in the recent U.S. election.
The stakes for investors could be high: Political uncertainty can undermine economic growth and corporate profits, while the clarity that can come from the conclusion of a contentious campaign can be good for growth.
What countries are we watching and what has us most concerned?
We don’t believe another country will vote to leave the EU in 2017, but four countries are top of mind for us this year. Some of them are more concerning than others, so we’ve created a scale of one to five (one being low concern and five being higher concern) to describe the risk posed by each:
What's at stake
Our level of concern
Election for the Second Chamber of parliament.
The Netherlands uses a proportional representation system to choose a prime minister. As of early February, the top two parties in the polls1 were the far-right anti-EU Party for Freedom (PVV) and the center-right People's Party for Freedom and Democracy (VVD). Neither is likely to attain a majority, so a coalition may be necessary. If the PVV won, it could struggle to find other partners because party leader Geert Wilders is considered to be divisive.
The PVV wants to exit the EU but is unlikely to form a coalition government. Although the Netherlands is a small country, a “Nexit” could have a large symbolic impact for the future of the eurozone.
April 23 and May 7
General election starting on April 23, with the runoff on May 7 if no party receives a majority in the first round.
The presidency is up for grabs. The far-right National Front (FN) party’s candidate, Marine Le Pen, who supports exiting the EU and euro, is leading the polls. However, “leading” in this case means 25% support,2 which could mean a second round of voting, where Le Pen could face a tougher race. The FN has limited broader support and voters tend to coalesce behind centrist parties in run-offs. Even if she won the run-off, Le Pen could struggle to govern without an FN majority in parliament, which is unlikely even after the June 11 and June 18 parliamentary elections. Therefore, Le Pen may be forced to soften some of her positions to effectively govern.
France is the second-largest euro-zone economy, and the euro zone might not survive a “Frexit.”
Germany uses a proportional representation system in parliament to choose its chancellor. Chancellor Angela Merkel of the Christian Democratic Union is running for a fourth term. While Merkel’s popularity has fallen and the anti-immigration Alternative for Germany (AfD) party gained some parliamentary seats last year, some form of mainstream coalition is likely to prevail.
Germany is the largest euro-zone country, but has strong support for the EU.
Likely in mid-to-late 2017
Italy’s government is in a precarious position—the country installed its fourth un-elected prime minster in a row in December 2016 after a constitutional referendum failed—raising the possibility of an early election. The vote is due by May 2018, but the second half of 2017 is more likely.
The anti-euro Five Star Movement (M5S) is neck-and-neck with the ruling Democratic Party (PD) in opinion polls. The M5S has a long-standing promise not to join with other parties, but a coalition with the Northern League could threaten an exit from the EU.
Italy is the third -largest euro-zone economy, holds significant government debt and bad bank loans. The bloc might not survive an “Italeave.”
Arguments against a Brexit repeat
Whatever happens in the elections listed above, it’s important to understand that comparisons with the Brexit vote aren’t necessarily appropriate because the UK is unique in ways that made its path to the vote more direct.
- Currency: The UK has its own currency, which made a break easier. The other countries listed above all use the euro. At this point, there is no legal provision for leaving the EU without also leaving the euro. Doing so would be very destabilizing economically, politically and socially. Majorities support the euro in all euro-zone countries.
- Identity: People in UK have traditionally identified more closely with their country and not as citizens of the EU. In contrast, the people of Germany, France, Austria, and the Netherlands feel they are citizens of the EU—although those polled in Italy are split on this issue.3
- Confidence in a future outside of the EU: A majority of UK citizens believe their country faces a better future outside of the EU than if they remain a part. This view has been steady for the past three years. In contrast, citizens in euro-zone countries tend to view a future in the EU more favorably, though people in Italy and Austria are somewhat undecided on this question.4
- Geopolitics: Citizens of many EU countries believe that being a member of the bloc affords greater peace and standing in the world.5 This is not the case in the UK, perhaps because it is a nuclear power, a permanent UN Security Council member and geographically isolated.6
- Support for a single European market: Around eight out of 10 Europeans support the free movement of people, goods and services within the EU. The UK has polled as the least supportive of the single market, though a majority still support the concept of a single market.7
How would exit votes impact the investment landscape?
Again, other countries would have to jump higher hurdles than the UK did with its vote, but if it looked like another country were preparing to break with the EU, the uncertainty could hurt economic growth in that country and perhaps lead to another financial crisis in Europe.
On the flip side, the existing uncertainty may already be suppressing growth, so if voters definitively repudiate exit talk, growth could pick up. Removing the uncertainty could be a boon.
What should investors do?
The lesson from 2016 seems to be that polling is an inexact science and the unexpected can happen. However, it’s worth noting that anti-establishment parties have generally had difficulty sustaining their early momentum and tend to see their support tail off into elections. This is what happened with votes in Spain, Hungary and Iceland last year.
The near-term risks to European stocks are heightened by the uncertainty posed by these votes. However, the resulting political uncertainty isn't sufficient reason to abandon global diversification. Having a diversified portfolio is one of Schwab’s 7 Investing Principles, as it has been nearly impossible to predict which asset class will perform best in any given year.
¹ Source: Ipsos, 2/2/2017.
² Source: Ifop-Fiducial, 2/2/2017.
3 Source: Eurobarometer, European Commission, 11/2016.
4 Source: Eurobarometer, European Commission, 5/2016
6 Source: BCA Research, 6/2016.
7 Source: Eurobarometer, European Commission, 5/2016.
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