Fed up with how all the economic, financial and policy news out of Europe have been contributing to equity market volatility?
Well, not only will this continue but, now, we must also get ready for something new over the next few weeks: the impact of elections. Here is a quick simple guide for what to look for:
Think of this particular election cycle as starting on Sunday with the first round of the presidential elections in France, where no single candidate is expected to gain a majority. It continues in a big way on May 6th with the second round in France, as well as the Greek parliamentary elections and German regional contests. And, for now, it ends on May 31st with the Irish referendum.
In each of these contests, politicians are offering voters differing interpretations of the past and, much more importantly, different visions for the future.
This is particularly true in Greece. In this struggling economy, the contest is defined primarily between those willing to continue with the austerity program agreed between the "technocratic government" and the "troika" (consisting of the European Central Bank, European Union and the International Monetary Fund), and those that would opt for something different. For investors, it boils down to a contest between a still-challenged Greek policy approach and one that would involve even greater credit and exit risks.
Issues are more nuanced in France, the euro zone’s second-largest economy. This is not because of the positions of Francois Hollande, the main challenger to President Nicolas Sarkozy. He has been constant in his commitment to seek revisions to elements of the euro zone approach to reflect less austerity and more growth. The uncertainty has to do with Sarkozy. In his attempt to catch up in the polls to Hollande, he has been altering his narrative and making new promises.
If President Sarkozy fails in his re-election bid, German Chancellor Angela Merkel will lose her most important ally at the core of the Europe – thereby complicating her attempts to strengthen the institutional and economic underpinnings of the euro zone. This may explain her decision to take the unusual step of essentially campaigning for Sarkozy. And it comes at a time when many are looking at the regional elections in Germany for indicators as to whether Merkel will be able to continue to govern after next year's national elections.
Then there is the Irish referendum. In what constitutes a first highly visible test, the government is seeking the electorate’s approval for the new European Fiscal Compact.
What should markets look for? For presentational simplicity, let us assume that you happen to be one of the very few people out there who limits your preferences only, and I stress only, to how your investments would be impacted. So, in simple aggregate terms:
• If you are long risk assets of any kind, and especially if you are max long, you would prefer a Sarkozy re-election in France, the emergence of a stable coalition of the major traditional parties in Greece, regional German elections that are supportive of Merkel, and the passing of the Irish referendum;
• If you are short risk assets and/or looking to add, you would prefer a win by Hollande, an ambiguous electorate outcome in Greece, setbacks for Merkel, and the rejection by Irish voters of the European changes; and
• For outcomes in between, you would need to add many months of political posturing to the other European elements that contribute to swings between risk on and risk off days in markets.
At times, elections can lead to uncertainties and, for investors, to a changing configuration of opportunities and risks. We are entering such a phase in Europe.
In addition to their consequential national impact, the series of forthcoming elections involve cross-border implications that influence prospects for regional policy coordination and, therefore, the nature and speed of the solutions for Europe’s debt crisis.
The author is Mohamed El-Erian, the co-CIO of Pimco, which oversees nearly $1.8 trillion in assets and runs the Pimco Total Return Fund, the largest bond fund in the world.