Friday 18 October 2019

Predictable gridlock, US style, has spread to EU

Uncertainty: Once campaigning for the 2020 presidential election begins, returns will slow. Photo: AP
Uncertainty: Once campaigning for the 2020 presidential election begins, returns will slow. Photo: AP

Ken Fisher

This year launched quickly, with US stocks up 18.9pc in the period to June, leading the world's 17.4pc stock market increase. The ISEQ and Europe, trailing for most of 2019, rose also - by 14pc and 17.3pc respectively.

European stocks should now smash expectations, thanks to unexpected twin political tailwinds. One, America's time-tested political gridlock - roundly hated by voters - counter-intuitively pushes prices higher globally. Two, a new unrecognised form of this same gridlock should drive Ireland and Europe higher. Here's how that works.

While US voters hate gridlock's squabbling and inactivity, markets love it.

Active governments shift rules often, forcing businesses to adapt, creating winners, losers and unintended consequences.

Gridlock blocks this, giving firms more future clarity, like an obstacle course with big, sharp, painful, fast-moving obstacles that becomes suddenly stationary.

Unlike Ireland and most of Europe, American elections occur on a fixed schedule - with no snap elections - making gridlock's impact clear.

The key: America's unique midterm elections late in every president's second year.

The sitting president's party routinely loses seats, complicating legislating. Hence, presidents pack big bills into their first two years, stoking volatility.

Since 1925, US stocks rose in just 58pc and 63pc of all first and second years.

But in year three, they rose 91pc of the time, averaging 17.8pc returns (in US dollars).

The last negative? 1939, World War Two's onset, and even then they fell just 0.9pc. Year three is a gridlock party.

Like 2019, it usually starts strong, celebrating midterms. That helps explain US stocks' year-to-date leadership.

But in the second half, America's returns slow as uncertainty over the next year's presidential election perks. That starts as soon as the Democratic Party's campaign grows.

While US stocks may slow, tied to rising uncertainty, Europe should benefit from falling uncertainty after May's European Parliament (EP) elections.

These also occur regularly, every five years since 1979. Fear hurts before voting, with typically slightly negative six-month returns.

But that flips afterwards, with European returns overwhelmingly positive in the six months post-vote, averaging 8.3pc, using each country's home currency.

For stocks, anticipation is worse than almost any result. Elections provide clarity and relief.

That's why America's year-three phenomenon is so strong and persistent. Same for EP elections, just different timing.

This year's should be turbocharged, thanks to populism fears raging across Europe. Before May's vote, investors dreaded political instability and radical policy - a false fear, as national parliaments demonstrate.

Populism's rise at European national levels hasn't caused radical legislation. It has brought nothingness - inactivity - and a new gridlock format.

Populism pushes political power from centrists to the ideological far right and left, pancaking it. That brings multi-party governments. Familiar to Irish voters, but new to the Continent.

Now coalitions are tougher to form and harder to maintain. Internal ideological divides block big bills. Italy is the poster child, with its populist coalition fighting among itself more than it fights Brussels. Sweden and Spain are also perfect examples.

May's results suggest the EP is no exception. While populists and Eurosceptics gained ground, they seized just 25pc of seats. Pro-EU parties took more than half.

However, the two traditionally dominant parties - the European People's Party and the Socialists & Democrats - claimed just 44pc combined. It's their first time below 50pc. Centrists are losing clout. So a multi-party coalition is necessary. The more parties in, the less big legislation passes, as there are too many internal squabbles.

It's especially true in the EP, since parties are really mashed up collections of loosely affiliated national movements.

As gridlock's inactivity dawns on investors, relief ensues. Instability fears should wane, commencing European stocks' post-EP election party. Ireland should benefit too.

Irish stocks' European correlation is 0.73 - nicely positive. The identical movement is one; the exact opposite minus-one.

Ireland may not lead the charge, as Brexit uncertainty could weigh, tied to still-unresolved Irish border issues. Company-specific drivers also matter for smaller indices, like the ISEQ. But for Europe broadly, falling uncertainty should fuel this bull's next leg up.

Ken Fisher is the founder and executive chairman of Fisher Investments, and chairman and director of Fisher Investments Europe

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