Government or No, Watch Spain Grow

For regular news consumers, we understand if recent headlines have you down in the dumps. Seems to us the media is doing a fairly effective job lately of highlighting the negative. To remedy this, here is some largely overlooked good news: The eurozone, frequently maligned throughout this global expansion, reported its 12^th straight quarter of GDP growth in Q1 2016, accelerating to 0.6% q/q (2.2% annualized). Spain, one of its biggest economies, separately announced its contribution to that streak, expanding 0.8% q/q (3.2% annualized) in Q1. While this may not be a huge surprise-Spain has been one of the eurozone's top economic performers recently-there is an interesting wrinkle: Madrid hasn't had a government since December. Spain's story teaches a timely lesson to investors: Political uncertainty doesn't automatically derail economic growth.

For a quick recap, Spain held parliamentary elections last December, and the establishment lost ground to "outsider" groups-a first in the historically two-party state. The incumbent center-right People's Party (PP), led by Prime Minister Mariano Rajoy, won the most seats but lost its majority. The center-left Socialists (PSOE) won enough seats to form a unity government with the PP, but both sides rejected that option. Hence, forming a government became a race to win over at least one of the upstarts, far-left Podemos and centrist Ciudadanos, and maybe even niche groups like the Catalan nationalists. In January, Rajoy turned down an offer to form a new government, as he lacked his party's support to do so. The Socialists tried and came close, but Podemos refused to compromise on certain demands, like calling a binding referendum on Catalan independence. After party leaders failed to form a coalition, King Felipe VI called for new elections on June 26. Based on current polling, the contest looks likely to deliver another stalemate, extending gridlock.

Despite the upheaval and stalemate, the economy didn't come to a grinding halt-it grew! Though we don't have a detailed component breakdown yet, that 3.2% annualized growth is a big counterpoint to those who argue political uncertainty-or even outright not having a working government-meaningfully disrupts the economy. A closer look at Spain's economic composition shows why. In terms of spending, the government comprises a little less than 20%, compared to households' share of almost 60%.^[i] Sector-wise, "Public administration, health and education activities" is about 17% of GDP.^[ii] But even the public sector components don't stall when there is no government. A caretaker administration still oversees the various ministries. Civil servants keep the hamster wheels turning day by day. Life goes on.

The private sector-83% of Spain's economy-is where recent growth has come from. From Q1-Q4 2015, household spending grew 1.1%, 0.8%, 1.0% and 0.7%, respectively.^[iii] Exports of goods and services rose 1.0%, 1.4%, 1.8% and 0.9% over the same timeframe. A broad swath of subsectors grew: wholesale and retail trade, information and communication, professional activities and arts, entertainment and other services. Even manufacturing grew nicely, rising 0.9%, 1.4%, 1.0% and 0.7% on a quarterly basis through 2015. Q1's headline growth rate is also in line with Spain's recent trend: The economy grew 0.9%, 1.0%, 0.8% and 0.8% sequentially in 2015's four quarters, with Q1 2016 matching the prior two quarters. If the uncertainty of not having a government is supposed to hurt growth, Spain's reality counters that.

Even if political uncertainty persists, that needn't hurt Spain's future prospects. The country has currently gone 139 days sans government. Seems long! Yet Belgium went 589 days with no government from June 2010 to December 2011, and its markets were fine for the first year of that inaction-until the broader eurozone crisis enveloped all members and spurred a global market correction later in 2011. Spain's lack of government means the status quo and gridlock, and gridlock isn't a negative for the economy or markets of competitive developed countries. Rather, it lowers the likelihood that radical new legislation-the type that spooks markets, like changes to property rights-becomes reality. Similarly, gridlock makes it difficult to pull back existing rules, including the structural economic reforms (e.g., dropping the corporate tax rate and relaxing rigid labor laws) that have benefited Spain. Concerns about the upcoming June election could knock investor sentiment and spur some uncertainty-human beings are fickle, and worries come and go. However, reality is much better than many investors believe-a reason to be bullish.

The political uncertainty clouding Spain's solid economic growth is but one overlooked positive on the Continent. France, another country that reported its Q1 GDP, grew 0.5% q/q (2.2% annualized), led by private consumption. Ireland resolved its own two-month long stint without a government as its two main political parties (Fine Gael and Fianna Fáil) agreed to form a minority government-virtually ensuring (positive) gridlock for the foreseeable future. Now we aren't saying everything across the 19-member bloc is peachy-Greece, after all, is still Greece. However, considering the eurozone's underappreciated growth streak has largely offset slowdowns in other parts of the world, we believe dourness toward the region is unwarranted.