Will UKIP Affect European Stock Markets?

UKIP leader Nigel Farage is a focussed on winning the up-coming European parliament elections. What effect would his appointment have on stock markets?

Emma Wall 12 May, 2014 | 7:30AM
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Emma Wall: Hello and welcome to the Morningstar Series, Why Should I Invest with You? I'm Emma Wall and here with me today is Stuart Mitchell of the SWMC European Fund.

Hello, Stuart.

Stuart Mitchell: Good morning. Hello.

Wall: So there is a lot going on in the macro situation with Europe at the moment. I thought we would start with the biggest cloud over European investors' heads and that's Ukraine. How much of an impact does that have on European stock markets?

Mitchell: In our view the impact will be very, very limited. At the end of the day, markets are driven by earnings and driven by the outlook for the industry in general. And we think the impact will be absolutely minimal. In our view also in terms of geopolitics, what's happening now is something which perhaps should have happened in the last 20 years, is the rewriting of the boundaries between the kind of liberal pro-Western part of Ukraine and of course the more Russian soviet orientated Eastern part of Ukraine. And in our view because there has been so little reaction from major political leaders, it's something which has kind of been accepted tacitly anyway.

Wall: Talking about those major political leaders, we have got some upcoming European elections at the end of this month. How much does that impact European industry?

Mitchell: In our view, the impact again will be very limited. I mean, we think that it likely will be a quite strong anti-European protest vote and we will more likely not see that in Britain, we could see it in France and even in Germany. But at the end of the day, austerity proceeded slightly with very little civil disobedience and objection. The majority of people, in almost every country in Europe, wants to remain part of the Euro. So we think the elections which are really critical are the large kind of national elections. That's when the decisions about Europe are made, not a protest vote at the European level.

Wall: And we have got some of those coming out this year, haven't we?

Mitchell: We have indeed. So the European elections will be coming, I think the next three weeks and in our view there could be some, even in the U.K. it's possible UKIP could again become the largest party. But again, it's more of protest thing and at the end of the day our view is that, the majority of the people within Europe want to have a closer tie, closer integration. And that's been supported by all the opinion polls around about the Eurozone and views in general of where they can – European Union – which direction European Union should move.

Wall: So Farage isn't necessarily going to have a negative effect on stock markets then?

Mitchell: We don’t think so. We don’t think so. It's kind of interesting isn't it, Farage, because in our view it's more of a kind of protest, anti-political thing. We don’t believe the debate has really begun in a serious way in the United Kingdom about Europe and in our view it's very much Cameron is to win to present the pro-European case at some stage, as long as he can get some kind of rewriting of the boundaries and perhaps some kind bring back at par to the U.K. But I think that – the serious debate hasn't yet happened.

Wall: If it's not the European elections and it's not the Ukraine that are the challenges for you as an investor in European stocks, what are the concerns?

Mitchell: At the end of day for us, it all comes down to earnings. Earnings are everything and of course, European elections and what's happening in Ukraine just has very, very little impact. What could really upset the outlook for our companies we think is, first of all, China. And I think there's a very significant risk that economy could sit on quite a lot further. So we have very little exposure to anything, which is China-facing in our portfolio, so anything emerging world-facing in our portfolios.

I think the other thing which is maybe more controversial, but what has surprised us recently in our company meetings is that, when companies talk about America, they often say that the recovery, the follow-through hasn't been quite as great as some people expected. And we just have to be very careful that anything particularly U.S.-focused, we're not being a little bit too optimistic on the earnings outlook. But the other flipside of that is of course, Europe is surprising, surprising, surprising, and we think earnings will be significantly higher than most people will expect in the next one or two years.

Wall: So you seem to suggest then that perhaps those most appealing European stocks are those with sort of domestic revenue focus of Europe, of U.K.?

Mitchell: That's very much our view. And curiously enough, it's – we are two or three years into the bull market and yet domestic European stocks have still lagged dramatically behind. And of course, the main reasons are, there's still kind of risk premium around the euro. And most people are very skeptical about any sort of recovery in Europe. And people like us are out on the road everyday visiting companies. We've just been astonished by the rapidity of the recovery.

And also the risk premium continues to come down. I mean, would you believe it, Italian and Spanish government bond yields, now yield less than American government bond yields. It's dramatic what's happening and it hasn't still been reflected we think by stock markets.

Wall: Stuart, thank you very much.

Mitchell: Thank you. 

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar