16 MAR

2017

Asset Allocation, Topics

What if… the European political risk premium declined?

As the Dutch general elections kick-off a busy European political agenda, we note that the political risk premium remains a major obstacle for inflows into European equities. Clearly, the start of the Brexit negotiations and elections in several major European countries have translated into economic policy uncertainties. The good news is that, within fewer than 40 days, predictability should increase somewhat.

For the markets, the Dutch election results might give insights into French polls. The results of the general elections in the Netherlands will be scrutinized:  the anti-EU PVV was not able to win the expected 25-30 seats, confirming that opinion polls have correctly judged the limited rise of euro-skepticism and populism. This might lead markets to reevaluate expectations of a Le Pen victory in France.

The 2-year Brexit clock should start ticking end-March. Just days after the celebration of the 60th anniversary of the Rome treaties, the UK is expected to trigger article 50 of the Lisbon treaty, which gives the departing country up to two years to negotiate “its future relationship with the Union”. The UK position (i.e. pull the UK out of the single market for goods and services, prioritizing control of immigration, laws and budget over economic concerns) and the EU position (focus on a Brexit bill based on agreed commitments; resolve citizenship rights and establish borders; start negotiations on a future trade agreement thereafter; no “cherry-picking”) should lead to fierce negotiations.

In spite of these known unknowns, the economic news flow has been robust in recent months, allowing the European corporate sector to exit its profit recession. This has led European equity markets to recover some of the ground lost since 2015. So far, equity fund flows have stabilized but are nowhere near to recovering last year’s outflows. A decline in the political uncertainty would lead to further upside potential.