The stock market sees nothing to worry about—that may be about to change
- Europe's economy is performing the best in many years on many key measures.
- Stock markets are currently behaving as if there is nothing to worry about, but that may be about to change now that we are within 45 trading days of the French Presidential election.
- Savvy investors should be prepared for a rise in volatility in global stock markets in the coming months.
The Eurozone economy may be in the best shape since the financial crisis:
- The January reading for the Eurozone Composite Purchasing Managers Index indicates that the Eurozone economy may be growing at its fastest pace in almost six years.
- The number of people employed in the Eurozone rose by nearly 3 million in the past year, returning employment to the all-time high seen in 2008.
- Loans to businesses have been rising at the fastest pace in seven and a half years, joining the rising index of leading economic indicators as a positive sign of future growth.
So what’s the problem?
Elections in the Netherlands, France, Germany and perhaps Italy are on 2017's calendar with potentially negative outcomes for investors. While markets are currently behaving as if there is nothing to worry about, evidenced by the market-based measure of future volatility in Europe’s stock market near decade lows, this may be about to change.
Source: Charles Schwab, Bloomberg data as of 2/17/2017.
While polls favor establishment candidates in the French elections (a first round on April 23 and likely run-off between the two leading candidates on May 7) and German elections in the fall, polls proved unreliable in 2016. A win by France’s Marine Le Pen in the Presidential election could lead to a crisis as she seeks to take France out of the euro and redenominate the country’s debt in francs, resulting in devaluation, default, and a huge shock to the financial system.
What do the next 45 days look like?
The critical period 45 days before the first round of the France’s Presidential election started on Friday. This timeframe is when stocks began to slide 5-10% ahead of 2016's key votes, as you can see in the chart below. Stocks rallied following the votes in 2016 as the outcomes became known and the uncertainty faded.
Source: Charles Schwab, Bloomberg data as of 2/17/2017.
What's the risk?
Le Pen's party, the National Front, has a passionate, but narrow base of support. This passion may result in the party taking the lead in the crowded first round of voting on April 23, but the limited support is likely to cause it to lag in the run-off between the top two candidates on May 7. The polls show Le Pen with a 20-point deficit in the second round versus establishment candidates. But polls, even when the gap is as wide as 20 points, are hard to count on after 2016’s surprise outcomes.
Instead, it may be useful to look back at the regional elections of 2015, when the National Front led the first round voting in six of the 12 mainland regions but failed to win any of them in the run-offs. Voters from other parties did not shift their support to the National Front, effectively keeping the party out. This illustrates that the pro-European candidate in the run-off (Emmanuel Macron or Francois Fillon) would probably receive the endorsements of the parties that drop out of the first round instead of Le Pen.
It’s important to keep in mind that for a potential crisis to develop not only would Le Pen have to win the Presidency, the parliamentary elections in June would also have to strongly favor the National Front (which currently only holds two seats in France’s 348-seat Senate) to have any hope of enacting her proposals. She would also have to successfully return France to the franc from the euro and to leave the EU—something the French people do not seem to want, according to recent polls (only 33% favor leaving as of December 2016).
Despite all these challenges, markets may begin to price in some uncertainty given the low probability, but potentially negative market outcome, of a "Frexit."
What about the other elections?
France isn’t the only European election of 2017, but others pose less risk to investors.
- The Netherlands election is on March 15. The Party for Freedom, an anti-European Union (EU) party, is expected to win the largest share of seats in parliament. However, other parties have already stated they will not form a coalition with the Party for Freedom. That makes it unlikely to be able to form a government to advance its agenda, posing little risk to investors.
- The German election will be held on September 24th. While anti-EU parties have gained support, with her approval ratings at a strong 74% as of January 30, 2017, it remains likely that Angela Merkel will win a fourth term as chancellor. While a status quo outcome may not pose a risk to investors, it is worthwhile to note that populist parties are pulling significant support from establishment parties. This erosion of the political center may mean Merkel’s influence and political capital will be less than in previous years as challenges from Europe’s vulnerable banking systems to its controversial immigration policies mount.
- While it could be delayed until 2018, Italy may hold an election in the second half of 2017, if it appears likely former Prime Minister Matteo Renzi's Democratic Party would win. While anything can happen, the most likely scenario of a win by the Democratic Party is of limited risk to investors.
What might happen?
Solid economic growth may help insulate Europe's stocks from political wrangling, but it doesn't make them immune. The stock market in Europe, and perhaps elsewhere if 2016 is a guide, may slide during the coming months. While markets reveal complacency among participants, savvy investors should be prepared for a rise in volatility in global stock markets in the near future.
- Follow Jeffrey Kleintop on Twitter: @jeffreykleintop
- Explore the investment help and guidance Schwab offers.
- Stay connected with the latest investing insights from Schwab. Follow the Schwab Investing Brief.
- Talk to us about the services that are right for you. Call our investment professionals at 800-435-4000.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.
International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.
The MSCI France Index is designed to measure the performance of the large and mid cap segments of the French market. With 76 constituents, the index covers about 85% of the equity universe in France.
The MSCI United Kingdom Index is designed to measure the performance of the large and mid cap segments of the UK market. With 109 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the UK.
The MSCI USA Index is designed to measure the performance of the large and mid cap segments of the US market. With 630 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the US.
The VSTOXX Index is based on EURO STOXX 50 real time options prices and is designed to reflect the market expectations of near-term up to long-term volatility.