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Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, as well as two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays).
Welcome to the Confluence Investment Management Biweekly Geopolitical Report for July 1, 2024. I'm Phil Adler. A tilt to the right in European politics has markets taking notice. Confluence chief market strategist Patrick Fearon Hernandez joins us today to give us an overview and discuss investment opportunities which may have been created as a result. Patrick, recent events in France where a far right party did much better than expected in a recent election did capture a lot of attention and so this might be a useful entry point for our discussion.
Phil Adler:What was this election all about?
Patrick Fearon-Hernandez:Well, thanks, Phil, and thanks for having me on the program. Now you're probably thinking about the early June elections for the European Parliament. Those elections took place across all the member states of the European Union in the 1st week of June or so. And candidates from far right parties substantially increased their representation in that body. Now in France, the far right did especially well, pulling in about 32% of the vote or more than double the share for president Macron's alliance.
Patrick Fearon-Hernandez:But here's where it gets more complicated. Since the far right did so well, Macron surprised everyone by calling snap parliamentary elections, the first round of which were held yesterday. Now the bottom line in all these elections is the EU voters are increasingly attracted by the far right's agenda, including new restrictions on immigration, reduced EU regulation, and a rollback in environmental rules.
Phil Adler:So you would say that this election in France does accurately mirror what has actually been going on elsewhere in Europe for some time?
Patrick Fearon-Hernandez:Yes. Like many other states in Europe, France in recent years has had to deal with high levels of immigration, a perception of increased crime by those immigrants, high energy prices, onerous regulations imposed on the politically powerful agriculture sector and and similar policies. In many cases, France's experience with these trends has been less severe than elsewhere in Europe, but the centrist elite dominated government has fueled perceptions that the country's leaders aren't willing to address these problems.
Phil Adler:Now, Patrick, would you say immigration is the main concern of the far right French political party and for that matter, all far right parties unsettled
Patrick Fearon-Hernandez:by unsettled by the growing diversity of their communities. The new multi racial communities around them just look so different than what they grew up with. In addition, a lot of younger voters see immigrants as jumping the line and competing with them for jobs, at least since the enormous wave of immigration from the Middle East a decade ago, the far right's been pushing for immigration restrictions, and more and more moderates are embracing that as
Phil Adler:well. How about support for Ukraine? How do Europe's far right parties stand on this issue?
Patrick Fearon-Hernandez:Well, there's actually a bit of a split on this issue. Remember, there's actually a couple of different far right parties or groups in the European Parliament. First, there's the European Conservatives and Reformists Group or the ECR, which is made up of representatives from far right national parties such as the Brothers of Italy, Spain's Vox, and Poland's Law and Justice party. Then there's the more hard right Identity and Democracy Group or ID, which includes national parties such as France's National Rally and Belgium's Vlamis Belang. Many of the national parties in the ECR ECR are now serving in or have recently served in their respective national governments, and that experience has tended to moderate them.
Patrick Fearon-Hernandez:For example, Italian prime minister Giorgio Maloney of the Brothers of Italy party has actually been a strong and consistent supporter for arming Ukraine. In contrast, it's the harder right ID and other right wing politicians that have been friendlier to Russia and have opposed further aid to Ukraine.
Phil Adler:Patrick, I I was able to visit Europe last year. And and while I was there, I listened to a lot of complaints from Europeans, particularly younger Europeans about the cost of housing. Is this a major source of support for the opposition or far right parties?
Patrick Fearon-Hernandez:Well, it surely is. In the recent polling that shows the young being especially against immigration, it appears that part of that concern stems from a perception that immigrants are driving up home prices and apartment rents. There's also a concern that immigrants are getting special state support to pay for housing, food, and the like, giving them an unfair edge. But remember that the housing issue isn't really just about immigration. In most European countries, home mortgages typically have floating interest rates in contrast to the fixed rates so common in the US.
Patrick Fearon-Hernandez:With the European Central Bank keeping interest rates high, mortgage interest rates rates are also high and are boosting monthly payments.
Phil Adler:Patrick, we in America can't help but view European politics through the lens of what we're familiar with, the workings of our own government. I found your overview in in your written report this week of the different branches of European government very helpful as I tried to better understand exactly how Europe operates. There are certain similarities to America, but also differences. What are the the most important to keep in mind?
Patrick Fearon-Hernandez:Well, the way I think of it is that the EU has 2 key decision making bodies that have fairly direct corollaries with the US. First, the European Commission is their executive branch. So it's similar to the president, the White House staff, the cabinet, and the various federal departments and agencies in the US. That's the European Commission. Now secondly, the European Parliament is in some ways similar to the US House of Representatives in that it represents the people of Europe on a proportional basis.
Patrick Fearon-Hernandez:Now, the really confusing bodies for Americans would lie in between those 2. Now the European Council consists of the actual national leaders of each EU member state, similar to the way the US Senate has 2 senators from each state, no matter how big or small its population is. But the European Council only provides advice and political direction. It has no law making power. Its sister body, which has a confusingly similar name, is the Council of the European Union, which is made up of the top government ministers from each member state.
Patrick Fearon-Hernandez:Because of its equal representation and the fact that it must approve proposed laws along with the European Parliament, it also has some elements of the US Senate. But it's important to remember that EU voters don't elect the council directly. Of these 4 bodies, the European Parliament is the only 1 that voters elect directly.
Phil Adler:I was wondering when we consider the European Parliament voting, are are European voters more active participants in this election than we see here in America?
Patrick Fearon-Hernandez:Well, on balance, the participation rate for the European Parliament election has been rising in recent cycles, and it's perhaps a bit higher than the typical participation rate in the US presidential election these days. But keep in mind that in some EU states, such as Belgium, voting in the election is actually mandatory.
Phil Adler:I was also wondering, are European government bodies, which in in many cases are very sensitive to coalitions, are are they quicker to respond to the will of the voters than what is the case in America?
Patrick Fearon-Hernandez:Well, I would look at that more as a reflection of the parliamentary system of government and the awarding of seats on a proportional basis rather than the first past the post or winner take all system that we use. Again, it's something that seems really, really foreign to US voters who have never had to think about how different an electoral system can be.
Phil Adler:Well, let's return to France where we began. You pointed out that French president Macron in response to the recent vote, the the 1 in early June, called snap elections for the French National Parliament. What what is he thinking?
Patrick Fearon-Hernandez:Well, it's pretty clear that Macron was gambling that the French far right embodied by the National Rally Party would fall on his face either in the election or if they won a majority in parliament and installed their leader as prime minister, that they would eventually fall on their face governing the country as well. It was a huge gamble, actually.
Phil Adler:And how have markets reacted to this?
Patrick Fearon-Hernandez:Well, we've been struck by how badly the markets have taken the European elections in general and especially the political uncertainty in France. In particular, French stocks and bonds have taken a beating. In fact, even pushing French bond yields above those of even lowly Portugal.
Phil Adler:Well, if voters come back to the center as president Macron desires, are there investment bargains to be had right now?
Patrick Fearon-Hernandez:Well, in writing our article, we did think that, that could be the case. Now, we thought the sell off in French assets could be a chance to buy good quality companies at a low price with the expectation that their value could rebound if the centrist parties win the election. But I also wanna emphasize what I mentioned earlier. It looks like a lot of far right European parties have become more moderate the closer they got to power. So even if the national rally ultimately comes out on top of the French election, it could avoid the scarier parts of its agenda such as budget busting, tax cuts, and populous spending programs.
Patrick Fearon-Hernandez:That would also mean that today's weak prices for French assets could indeed be a buying opportunity.
Phil Adler:Is now the time to to pull the trigger on these potential opportunities?
Patrick Fearon-Hernandez:Well, we're actually in the midst of our quarterly asset allocation strategy updates, so we'll certainly be talking about it here at Confluence. However, at this point, I can't tell you what exactly will ultimately decide.
Phil Adler:Patrick, 1 more question. Confluence Investment Management has identified European defense related companies as as opportunities for investment. Now are you comfortable with that recommendation even if far right parties, at least those that would pull back support for Ukraine, continue their ascent in Europe?
Patrick Fearon-Hernandez:Well, I still think it's a good bet. First, as I mentioned earlier, a lot of Europe's far right parties have taken more moderate stances once they've gotten more power, such as prime minister Maloney's brothers' Vitale party. Also, some Eastern European states more at risk of Russian aggression, such as Poland, have recently shifted away from far right parties that were friendly to Russia. That's likely to be a lesson for other far right parties. In France, for example, even Marine Le Pen of the national rally has recently offered assurances that a government run by her party would support additional aid to Ukraine.
Patrick Fearon-Hernandez:There certainly might be more resistance to European defense rebuilding, but we think the increasing fear of Russian aggression will continue to fuel greater defense spending in Europe.
Phil Adler:Thank you, Patrick. Our discussion today is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security. Our audio engineer is Dane Stoll.
Phil Adler:I'm Phil Adler.