Words ought to be a little wild, for they are the assault of thoughts on the unthinking
- J.M. Keynes

Friday, 4 May 2012

Quick Note on European Election Weekend

Election weekend is here and even though the verdicts will have little fundamental impact (apart from Greece) they are sure to generate impassioned headlines. And since headlines determine short-term market direction, the results are more important from the perspective of the market than from the perspective of the European economies. 
The markets have baked in some amount of negative outcome so a positive surprise may lead to a temporary bounce in European risk. A quick note on the four elections results to look out for, in decreasing order of market importance:
  1. Greece: National parliamentary elections. This has the potential to spring a nasty surprise especially since the market has taken its eyes off Greece.
    1. Market’s expected scenario – Shabby coalition (with/without Democratic Alliance) which professes to stick to the IMF/EU schedule.
    2. Positive outcome – ND and PASOK win a big majority and the far left and far right have marginal influence.
    3. Negative outcome – Fractured mandate with far left and far right capturing a better than expected share of the vote.
    4. Order of probability: Expected > Positive > Negative
  2. France: Presidential election. The reason why this is lower on the list is because unlike Greece the impact on Eurozone will not be immediate (but the impact on markets may be). Also Hollande can pursue policies which mitigate the market’s current fears.
    1. Market’s expected scenario – Hollande victory
    2. Positive outcome – Sarkozy surprises by snatching almost all of Le Pen’s support.
    3. Negative surprise – Hollande victory accompanied by harsher anti-capitalist/anti-market rhetoric.
    4. Order of probability: Expected > Negative > Positive
  3. Italy: Local elections for Mayoral and Council offices. The press has tried to make it into a referendum on Monti. It isn’t. But headlines will roll (and roil) nonetheless.
    1. Market’s expected scenario – Fractured verdict with no clear winners or losers.
    2. Positive outcome – Centre-left and centre-right parties take a major share of the vote which will be spun as a vote of confidence in Monti.
    3. Negative outcome – Given the internal machinations of Italian politics, any verdict which sparks off speculation of Monti departure. This may be due to a better than expected showing for Northern League or a vote which makes some parties believe that they can form a government if elections are held soon. Given Monti’s individual popularity, the latter is unlikely to be followed through but uncertainty can cause market turmoil.
    4. Order of probability: Expected verdict > Negative outcome > Positive outcome
  4. Germany: Regional election in Schleswig-Holstein. This may make headlines but is largely irrelevant to the European situation. Regional elections are fought on local issues and a win/loss does not indicate acceptance/rejection of austerity etc.
    1. Market’s expected scenario – Merkel’s party (CDU) loses power
    2. Positive outcome – CDU/FDP retain power
    3. Negative outcome – Larger than expected loss leading to more sensationalist headlines
    4. Order of probability: Expected >> Negative ~ Positive
NB: I have intentionally not put numerical probability estimates. Putting numbers on highly uncertain events doesn’t remove the fuzziness. It only gives the (false) impression of precision.

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