"Many forms of government have been tried, and will be tried in this world of sin and woe. No one pretends that democracy is perfect or all-wise. Indeed it has been said that democracy is the worst form of government except for all those other forms that have been tried from time to time...” - Winston Churchill
A sting in the electoral tail...
European constitutional defences have held firm through a particularly fraught couple of years. The two round system in France helped deliver a win for the centre. Proportional representation stymied Geert Wilders in Holland. The Spanish authorities held the line in their latest secessionist test. However, could there be a sting in the tail of this most turbulent of European electoral cycles? The Italians trudge to the polls to no doubt express their dissatisfaction with what remains the most troubling of Europe’s major economies this Sunday. Meanwhile, this weekend will also tell us whether the membership of the German Social Democrats has decided to torpedo the proposed Grand Coalition with Chancellor Merkel’s CDU.
The latest polls, released before the blackout, still pointed to no single party gaining an absolute majority. The centre-right coalition, with octogenarian Silvio Berlusconi pulling at least some of the strings, looks likely to form the largest bloc. A large, heterogeneous and likely unstable, coalition will need to be formed given the current electoral split. As we pointed out earlier in the year, the likely best case is the ever familiar political stalemate and the worst, some backtracking on the important labour market and pension reforms enacted under Mario Monti and Matteo Renzi. Nonetheless, for investors with fingers already hovering over the sell button, there are a couple of things to keep in mind.
First, the birth of such a heterogeneous coalition is likely to be painful, but more importantly protracted. Second, even if EU-unfriendly forces were to manage to both win the election and form a workable coalition, the current constitution prohibits referendums on international treaties, including Italy’s membership of the euro. To change the constitution, a two-thirds supermajority would be required twice (in both chambers) before the question could even be put to the electorate.
The Italian economy, beginning to enjoy the fruits of the wider European recovery, will have to get along without a strong government. However, Italians and indeed investors may not notice the difference.
Last year’s German federal elections were inconclusive. The Social Democrats (SPD) lost significant ground and immediately ruled themselves out of another grand coalition for fear of further damaging their popular support. However, the failure of the so called ‘Jamaica’ coalition talks dragged the SPD back to the negotiating table, albeit with a stronger hand. An agreement was found, potential cabinet positions meted out, narrow approval of the party delegates secured and now the Social Democrats are asking for the final rubber stamp from their wider membership by postal vote – the results of which are due this Sunday.
However, over 24,000 new members, or over 5% of the total membership, have joined the SPD since the beginning of the year and will be eligible to vote on the Grand Coalition treaty. As their joining coincided with the young socialist campaign to attract new members to vote against the ‘Grand Coalition’ treaty, some are putting two and two together. In 2013, an approval of 86% of party delegates was followed by a 76% SPD party membership approval. This year, only 56% of SPD party delegates approved.
If, as certainly seems possible, the SPD membership rejects the coalition, what happens next? The choice would be between minority government and fresh elections. Neither option looks particularly appealing in the context of still rising support for the extreme ends of the political spectrum in Germany. Nonetheless, for investors, we would continue to argue that a ‘no’ from the SPD membership would result in foregone upside with regards to further European integration rather than immediate political, and capital markets, chaos.
If the worst-case scenario happens in both Italy and Germany this Sunday, we should expect European risk assets and the euro to wobble a little. However, neither would materially alter our conviction in continental European equities. This remains well founded on an increasingly robust and broad-based domestic economic recovery as described in last week’s article. We still contend that the noisy political foreground is unlikely to materially interrupt this rosy economic background. Admittedly, democracy can rarely have appeared messier, or more precarious, than over the last couple of years. Some may even wonder why we bother. However, this week’s removal of presidential term limits in China should serve as a healthy reminder of why we should still cherish the opportunity to change our leaders, good, bad or indifferent, after a period of years rather than decades.