Why Investors Should Pay Attention to the European Elections

The Rise of The Right

The polls are fairly unanimous: the parties on the centre-right (i.e. the European People's Party, or EPP) are likely to gain more seats and influence than ever before, and will probably be clear winners in several EU member states, including France, Italy, Hungary, Austria and the Netherlands. The Greens and Liberals are expected to lose seats. As a result, the next European Parliament will be more polarised and fragmented than ever before.

"Although we believe the centrists will still be able to maintain an overall majority, it cannot be ruled out that the EPP could also build a majority with the far right, which would give it significant influence when it comes to issues such as immigration, climate and further EU integration," says Nicolas Wylenzek, macro strategist at Wellington Management.

"How this potential rearrangement will alter EU policy will depend on a number of factors, including the composition of the European Commission, changes in the political landscape at member state level, and international developments such as the war in Ukraine and the US elections."

Despite the uncertainty, several longer-term political themes are obvious, and the Wellington strategist identifies five in particular:

'Less Green'

Some segments of the electorate feel climate measures have gone too far, and even more so now the energy price crisis has abated. The EU will maintain its focus on energy independence, but will slow its progression to net-zero. Moreover, some long-term initiatives – e.g. green hydrogen production – may lose momentum.

'Less EU Integration'

Increasing support for extremist parties suggests a growing loss of trust in government institutions. These voters also feel EU integration is moving too fast, which means certain projects, such as a capital markets union, could slow further. New proposals like the common defence fund may struggle to gain momentum.

'Less Immigration'

New laws have recently made it harder for asylum seekers to enter the EU, but the significant success of the far right could push the political dial further to the extreme. Such a move could further restrict an already-rigid labour market.

'More Business'

A common criticism of the European Parliament is it is too focused on regulation to the detriment of business. We might see efforts to reduce some measures, especially in key areas of national security and supply chain resilience. This could include semiconductors and critical minerals. We may also see a more permanent easing of state aid rules.

'More China?'

The next European Parliament could also become progressively more favourable to China if the far-right parties perform well. After the invasion of Ukraine, parts of the European far-right shifted their support from Russia to China. An increasingly pro-Beijing parliament could complicate relations between the EU and the US, which continues to push for decoupling.

There are two potential consequences here. On the one hand, a reduction of administrative burdens could be beneficial for EU companies. On the other, reforms that foster further integration, such as the banking union and capital market union, would strengthen the resilience of the European economy and facilitate growth.

All Eyes on Defence

Where energy transition was once the phrase du jour, common defence is now critical. EU member states want to work more closely on large-scale development projects such as next-generation tanks and fighter jets, and strengthening the European defence industry to reduce import dependency.

"We see this growing boost in European defence spending as a clear benefit for European defence companies, which will benefit from both a strong tailwind and better visibility on demand in the medium term," Wylenzek says.

"Moreover, unlike suppliers involved in the energy transition, defence contractors are protected by much higher barriers to entry. Although valuations have risen significantly, we believe that selected stocks remain attractive from a long-term perspective."

Why Are European Equities on the Upswing?

As all this unfolds, European equity markets are doing well. Having started 2024 on a strong note, the Morningstar Europe Index has gained 10.7% since the start of January.

Regardless of the composition of the new Parliament, "the Mid-Term Review of the Next Generation EU has been successful and we are, according to the Commission, about to enjoy the maximum macroeconomic impact of the plan's investments." So says Alessandro Tentori, chief investment officer for Europe at AXA Investment Management.

"Consumption is recovering in Europe, the energy shock is receding and we are forgetting about it," says Niall Gallagher, investment director, equity Europe at GAM.

"We believe inflation will come down a bit more, however it will remain higher than before and also more volatile, although not to the levels of the last two years. In our view, this will allow real wages to rise and this will also have positive effects on consumption."

However, the manager warns some areas of the market are currently overvalued – especially growth stocks. Valuations have risen again as the market has started to discount the decline in interest rates.

"If rates don't fall, or if they don't fall as quickly as investors expect, we believe that there are some growth stocks in Europe that could be affected by the compression of valuations," Gallagher says.

"We therefore need to pay attention to that risk."

"Overall, despite the evolving political landscape, which we view as marginally negative, we remain positive on European equities, given the improving growth environment and strong fiscal support, with a preference for European banks and domestic consumer beneficiaries such as the travel and leisure sector," Wylenzek adds.

"We favour defence from a cyclical point of view and healthcare, telecom and utilities from a more defensive point of view.

"More broadly, the recent strong performance of European equity markets, excluding the UK, suggests that global investors have started to re-pricing European equities in the wake of Europe's burgeoning growth recovery and US market concentration risk.We believe this trend is still ongoing."