Actual Political Action—on the Iberian Peninsula

Editors’ Note: MarketMinder prefers no party nor any politician. We assess political developments for their potential economic and market impact only.

We are still nearly a year away from next year’s US presidential election, but the political scene is anything but quiet. On our shores, investors remain bogged down with the leading candidates’ unpopularity and uncertainty over whether primary races on either side will heat up. In Britain, the ruling Conservative Party is enduring a crisis that threatens an irreparable split. That is, to this point, mostly talk and chatter. But on the Iberian Peninsula there is actual action: Just as Spain’s incumbent prime minister finally reached an alliance with a small party that looks set to pave the way for a confidence vote next week, Portugal’s president announced the country will hold a snap election in March to replace Prime Minister António Costa, who resigned this week due to a corruption scandal. What should investors know? Read on.

Spain’s coalition agreement promotes gridlock and ruffles some feathers.

Waaay back in July, which feels like an age and a half ago, Spain held a snap election as incumbent center-left Prime Minister Pedro Sánchez bet that an early contest would limit the damage as the center-right opposition climbed in the polls. Surprising many observers, it worked: The center-right Popular Party, led by Alberto Nuñez Feijóo, won the most seats as expected, but its natural coalition partners weren’t sufficient to form a majority, and the opposition declined to abstain from a confidence vote and enable Feijóo to head a minority administration. So Sánchez got a bite at the apple and has spent the last several weeks negotiating with potential partners.

These negotiations now look complete. The easy (ish) one wrapped in late October, when Sánchez’s Spanish Socialist Workers’ Party (PSOE) reached a coalition agreement with the leftist Sumar alliance (which incorporated the leftist populist party Podemos). This was more or less low-hanging fruit since PSOE and Podemos governed together before the election, and their agenda was largely a warmed-over version of their prior to-do list. But it also didn’t cause much more than a ripple since Sánchez still needed support from Catalan separatist party Junts in order to win a confidence vote. That was a much taller order given their leader has been an exiled fugitive since holding an illegal independence referendum in 2017.

But now the PSOE and Junts have reached an agreement. In exchange for full amnesty for leader Carles Puigdemont and about 1,400 other activists and politicians involved with the referendum, Junts agreed to support PSOE’s legislative agenda for a full four-year term provided its leaders believe sufficient progress is underway on Catalonia’s political conflict and a new independence referendum. This has stirred no small amount of ire among the PP and other opposition parties, not to mention the general public. Protests are flaring in Madrid, and Thursday’s shooting of a prominent conservative Catalan politician has further frayed the country’s nerves.

At times like this, it is easy to focus on the sociological implications, and those are indeed important. But for investors, it is important to tune out everything that doesn’t connect to economic and market policy, lest emotion and bias sway decision making.

In this case, we see a couple of key relevant points. First, uncertainty is clearly elevated and may stay that way in the very near term. The confidence vote is set for next week, and even with Junts’ support, it isn’t clear Sánchez will win it. His multiparty coalition still lacks the seats to win a majority outright in the first round and will depend on a small Basque party (or other opposition members) to join or abstain from a second-round vote, when the threshold falls from a majority of parliamentary seats to a simple majority of voting legislators. Right now, the Basque Nationalist Party has said only that it will review the agreement between the PSOE and Junts before confirming whether it will support a new government. If they do and Sánchez wins, then uncertainty should fall as the current tensions simmer down and people get a clearer view of what the Junts amnesty (which will require a parliamentary vote) means. And if Sánchez doesn’t win a confidence vote by November 27, Spain will face new elections—extending uncertainty somewhat.

Either way, point two stands: Spain will be gridlocked. A Sánchez government would effectively have seven participating parties, which is a recipe for very little happening as different factions take advantage of their outsized influence. Sánchez’s prior government didn’t pass much, despite widespread fears that they would undo the previous decade’s pro-market reforms, and this new coalition would just extend the status quo. A snap election would likely yield a similarly fractured administration regardless of which party heads it, as polls don’t presently point to anyone winning a majority. Voters may hate the bickering and inaction, but markets typically enjoy gridlock, which gives them a break from contentious legislation creating winners and losers. Lower legislative risk enables more investment and risk taking, which stocks benefit from one even if investors never consciously realize it.

Portugal moves forward.

One country for sure heading to new elections is Spain’s Iberian neighbor, Portugal, where Prime Minister Costa resigned Tuesday after a corruption investigation ensnared his chief of staff, the infrastructure minister and several other members of his inner circle. Prosecutors haven’t implicated Costa, who maintains his innocence and has pledged to cooperate with the authorities, but police raids on government buildings and several politicians’ homes sealed his fate. After meeting with party leaders on Wednesday and Thursday, President Marcelo Rebelo de Sousa announced the country will hold elections on March 10.

Here, too, uncertainty is high. Costa had been in power for eight years and had a rare absolute majority in Parliament. His party still tops the polls. Yet it also needs a new leader and must rebuild its reputation after being dogged by various corruption allegations for years. Meanwhile, the center-right opposition is polling very close behind, and a more populist right-wing party is on the ascent. And with nearly four months until the vote, there are numerous ways this could go.

But as uncertainty falls gradually and stocks gain more clarity, markets should move on to weigh the post-election environment and assessing the likelihood that the next administration—whichever way it leans—will be able to pass much legislation. Here, the recent past might be a helpful guide. When Costa took power in 2015, investors were very nervous that reforms enacted during the eurozone debt crisis would bite the dust, reversing the country’s improved creditworthiness and economic competitiveness. But that didn’t happen. Despite some changes at the margins, Portugal’s recovery from the crisis continued—just like Spain’s did under similar fears when Sánchez took power. Markets moved on.

This time, we suspect markets would see a new Socialist-led administration as an extension of the status quo. Gridlock, too, would probably bring relief. If the center-right wins, we can envision a scenario where markets get overly optimistic about pro-market reforms in the run up to the contest, then come back to earth if reality proves disappointing—similar to what we are watching for in Greece. Not that we are playing favorites or anything, but it is always important to remember markets move most on the gap between reality and expectations, and not the party and personalities of the people in charge.