Expected gains, unexpected outcome

The weekend started with the election of the European Parliament and ended with the announcement of snap elections in France. On the European level, the elections resulted in the expected gains for the far right, while the Greens and French President Macron’s centrist ‘Renew’ party lost the most. Macron reacted to these results by dissolving the National Assembly and calling for early elections.

With the Greens losing voters, most observers see continued delays in green energy initiatives as the most obvious consequence. However, more important for bond markets is a trickier path for European integration. All in all, we expect the European election outcome to have a limited impact on bond markets at this point.

Political uncertainty might also keep the sovereign spreads of highly indebted European countries from tightening further. In fact, we already see some widening following the election, but it is not sufficient to justify changing our preference for European periphery sovereign debt, which is still backed by the European Central Bank’s (ECB) anti-fragmentation tools and the easing bias that officially started last week.

How could this affect the economy and bond markets?

There will likely be only a marginal direct impact from the reshuffling of the European Parliament itself given the limited stand-alone power and the fact that the strongest alliance remains the European People’s Party, which backs a second term for European Commission President Ursula von der Leyen. Nevertheless, the election outcome ultimately reflects national voting tendencies, with the unfolding political consequence in France just a point in case. Similarly, the German government will likely be further weakened by the election results.

Equity strategy: Diversifying into Europe

As was widely expected, the ECB cut its policy rate by 25% last week, effectively starting a gradual easing cycle to its monetary policy. European markets will likely benefit from the cutting cycle, as inflation has already slowed down significantly, and economic growth is set to pick up.

European equities currently offer an improving tactical risk/reward and cheaper diversification than the US market, which still shows a high concentration of Big Tech and artificial-intelligence compounders. Stocks in Europe are more diversified and enjoy a higher cyclical exposure than those in the US market. Hence, while we continue to recommend that investors gradually increase their exposure to cyclicals in anticipation of the new economic cycle, it is also worthwhile considering European equity markets more closely. We recently upgraded German equities to Overweight, since they have significant exposure to the business cycle, continue to show an improved earnings outlook, and are trading at appealing valuations. Moreover, from a fundamental perspective, our equity analysts also have a positive view on most of the stocks covered in the DAX index.

Since technological innovation will continue to play a big role and be dominant in the long term, the US equity market will most likely maintain its leadership. Nevertheless, favourable conditions are starting to emerge in Europe, making diversification efforts a potential boost for equity returns.

What does this mean for investors?

While it may seem things are changing quickly in Europe, the medium-term impact is limited for bond markets, while political uncertainty might keep the sovereign spreads of highly indebted European countries from tightening further. European equities offer opportunities for diversification from US equities as they are underowned, less concentrated, and cheaper than US stocks. Their diversified composition may also benefit from higher growth and lower rates in the second half of the year.