Lost in the Shuffle - Spain's Elections & Markets

Investors in global markets have a lot to digest – substantial value destruction in a number of sectors, the ongoing saga of the U.S. Federal Reserve, the upheaval in commodity markets (does anyone really know where oil is going?), and the stickiness of geopolitical risks. While many portfolio managers would no doubt prefer to solely look at corporate fundamentals, political risk remains a key factor in many sectors. One event that has failed to make headlines, but represents a potential market spoiler in Europe, is the December 20th Spanish parliamentary elections.

The reason Spain’s election matters is that the Iberian country is the world’s 16th largest economy, it is the fourth largest within the embattled Eurozone, home to a number of major global corporations, and has been held up by some as an austerity success story in the European Union.

The International Monetary Fund (IMF) in its Article IV Report in July 2015 noted about Spain: “Strong policy implementation has supported the return of confidence, and significant external tailwinds are helping the rebound.” The IMF pointed to labor market reforms, moderate wage growth, a regaining in competitiveness, a clean-up and stabilization of the financial sector and fiscal consolidation. The multilateral agency also forecast real GDP growth for Spain at 3.1% in 2015 and 2.5% in 2016, well ahead of France, Italy and Germany.

The IMF also noted that were points of concern, including high structural unemployment, a lack of economies of scale of the country’s many small firms, and still high public sector debt. Public sector debt is a little over Euro 1 trillion, equal to close to 100% of GDP. No doubt with an eye to the December 2015 parliamentary elections, the IMF added: “…a key risk is a reversal of reforms already carried out, which would create uncertainty and could hamper the economy, especially if the external environment were to deteriorate sharply.”

Well here we are – it is December and the election is days away. Opinion polls indicate that the ruling Partido Popular (PP) may not be all that popular. It appears that Prime Minister Mariano Rajoy’s ruling party could go from its current 186 to somewhere between 110 to 130 seats, well short of a clear-cut majority to rule without the help of others. Scandals, the sting of tough austerity measures and still high unemployment (21.6% in October) are taking their toll on the ruling party, which is seeking a second term (having won the 2011 elections from the Socialists).

The opposition Socialist Party (PS) could also see its representation in parliament slip from 110 seats to 90 seats. Although PS leader Pedro Sanchez scored points in his only debate with Rajoy, telling his opponent that he is “not a descent politician” due to the PP’s track record of scandals and chumminess with big business and finance, the Socialists are also seen by many younger Spaniards as part of the same problem. After all, the Socialists were in power from 2004 to 2011 and were blamed for much of the economy’s harsh downturn.

The big gainers are expected to be the left-wing and anti-austerity Podemos and Ciudadanos (C), a centrist business-friendly party with left-leaning social programs. In one of the last surveys before the election conducted by the Sociological Research Centre, Ciudadanos could capture 19% of the vote and around 66 seats. The same poll indicated that Podemos was on track to win 15.7% of the vote and around 49 seats. However, other polls indicate that there could be a three-way tie between the PP, PS and Ciudadanos.

The easiest forecast is that the PP is likely to capture a majority of seats, but will be short of an absolute majority. This leaves the door open to coalition politics in which the PP would seek to form an alliance with another party, most likely Ciudadanos. For the latter party this would take the form of either being an outright partner of a PP government or supporting the PP in votes in the Parliament. For this to transpire, part of a likely deal would be for Rajoy’s departure. The PP could also seek to rule as a minority government, which is not easy and carries a risk of being ousted by a vote of no confidence and more political uncertainty, much as happened recently in Portugal.

The Socialists could also seek to create a center-left coalition, including both Ciudadanos and Podemos. There are a number of problems with this alignment. First and foremost, the Socialists would probably have to give some key cabinet positions to the other two parties. Second, Ciudadanos is business-friendly and Podemos is populist with strong Marxist elements in its ranks.

In many regards Podemos is the potential joker in the deck of Spanish electoral cards. It is similar to Greece’s ruling Syriza Party, a “new wave” leftist grouping, spearheaded by a charismatic young leader. The Spanish party’s leader is Pedro Iglesias, a pony-tailed, 36 year old political scientist, who cut his political teeth in the Communist Youth and the anti-globalization movement. Articulate and media-savvy, he has tapped support among many of the country’s youth, who face an unemployment rate of 54% in the ages between 18 and 21 years of age.

Iglesias has stated that Spain’s politics are a “fundamental divide now between oligarchy and democracy, between a social majority and a privileged minority.” Stated in another way, it is between la gente (the people) and la casta (the caste). To remedy this situation, Podemos would seek to restructure the national debt, re-nationalize essential services such as healthcare and energy and provide a basic income that would help reduce unemployment for those currently not a part of the formal economy. To achieve such an agenda, the state would break up the oligarchy, raise taxes and nationalize the commanding heights of the economy. And, by the way, Podemos intends to bury the Socialist Party as the main force on the left, a factor that would no doubt complicate alliance building.

Podemos in power or near power would indeed be a game changer, much as it is in Greece with Syriza. If nothing else it would shake up Spanish politics and re-raise major issues about the future direction of economic policy in the Eurozone. While we expect Podemos will gain a number of seats in the election, which is a breakthrough, it is not likely to be the next government. Sorry Senor Iglesias. The real battle is between the PP (to hold on to a majority and gain a partner), the PS (to maintain itself as a major force) and Ciudadanos (to have a larger role in the political process). All of this points to the likelihood that Spanish politics have considerable potential to be volatile in the months ahead.

For anyone wondering how electoral politics can play out in an unexpected fashion they need only to look next door to Portugal, which held elections in October. Although the center-right ruling coalition won the largest number of seats and was given the authority to form a government, the opposition Socialists and two other leftwing parties voted the new government out in November. Portugal’s government is currently led by a Socialist prime minister, supported by two hard-left parties. This has raised questions over Portugal’s policy direction in terms of a badly needed restructuring of the economy.

It is worthwhile to note that markets have a relatively relaxed view of the Spanish election. As Alan McQuaid, the Chief Economist for Merrion (Dublin) observed on December 15th: “Thus far, markets seem unfazed. Spain’s 10-year bond yields are currently at 1.77% (below their US counterpart), down around 20 basis points from a recent peak in early November.” McQuaid also cautions, “After a year in which electoral polls have proved fallible, investors shouldn’t take anything for granted, and Spanish bonds may be vulnerable between now and year-end.”   

To this we would add, to finance its pubic sector debt, Spain continues to need access to international capital markets, where confidence in governments is key in assessing the political will to repay obligations. Talk of debt restructuring, such as that from Podemos, does not instill confidence.

European politics are very much in flux, as voters wrestle with hard decisions concerning employment, lifestyle and immigration as well as identity. There is also a generational dimension at play, especially in many southern European polities where the status quo has locked in employment for some, but has excluded others. Although the implementation of Podemos’s economic program would most likely be a disaster for the Spanish economy and would incur fierce resistance from both within and without the country, its call for greater transparency and clearer, more honest government are central to how political institutions in a democracy are expected to maintain their legitimacy. While global investors have every right to be focused on what the U.S. Federal Reserve does (which is to raise rates in December), they should not lose sight of other developments’ like Spain’s election, that have the potential to roil markets.