Now that the VVD party has emerged victorious in the Netherlands’ parliamentary elections, we expect the current administration to continue more or less in its current form – and possibly become even more aligned with Brussels.
In the Netherlands, coalitions are critical
On March 15, millions of Dutch voters went to the polls to elect 150 members of the Tweede Kamer (House of Representatives), which will use proportional representation to divide its 150 seats according to the number of votes won by each political party represented in the election.
Unlike in other countries, in the Netherlands it is virtually unthinkable to see one political party win a majority vote and lead the country; instead, governments run by coalitions are the norm because it takes 75 seats to form a government, and winning that many seats is extremely difficult. At the same time, forming a coalition is also very challenging: In 2010, coalition negotiations lasted 127 days – a relatively quick turnaround compared to 1977’s negotiations, which took a record 207 days.
These are some of the reasons why the last party that held an outright majority in the Netherlands was the Liberal Union party in the early 20th century. And they make the accomplishments of the current government, led by Prime Minister Mark Rutte of the centre-right VVD party, even more impressive. Mr. Rutte’s government was formed by a coalition with the centre-left PvdA party, and it is the first one since 2002 that has managed to serve its full term. His government’s staying power has provided the Dutch people with some generally much-appreciated continuity and added a new consideration for voters contemplating making a wholesale change.
What the post-election government will look like
Now that the election results are known, and the VVD party has emerged victorious, we expect the current administration to continue more or less in its current form, with possibly a few more members added to its ranks.
The coalition’s current members and prospective ones all seem to be united around the issue of education, and they are all pro-European Union. Of course, there are clearly big differences between these parties, so there will likely be protracted negotiations about the composition and objectives of the coalition. However, we do not believe this will prevent them from forming a pro-EU government – and possibly an even stronger one. As a result, we believe the Netherlands will not leave the EU any time soon.
Three core issues at stake
In the run-up to this election, security, migration and sovereignty were three of the biggest issues for Dutch voters.
The first two, security and migration, blurred together into one when terrorist attacks and Europe’s migrant crisis undermined the Dutch government’s credibility. Obviously, migration is a powerful issue throughout Europe, given German Chancellor Angela Merkel’s stance on refugees and Germany’s open-door policy. But in the Netherlands in particular, the anti-Islam, euro-sceptic PVV party found surprising support for its calls to limit migration, close mosques and ban the Koran from public buildings.
The other core issue for Dutch voters, sovereignty, was kept at the fore of the public’s consciousness thanks to the EU’s “freedom of movement” principle and Germany’s response to the migrant crisis. Dutch voters had to grapple with the idea that being a member of the EU meant giving up sovereignty, and the populists’ agenda gained some undeniable strength in this area. The Dutch system of proportional representation means that undeniably populist issues such as the freedom of movement and the future of migration will continue to influence both the domestic political agenda and the debate over the future of Europe.
A strong domestic economy
Overall, the Netherlands is in good shape economically and forms a strong member at the core of Europe. The gross domestic product of the Netherlands has returned to levels last seen before the Great Financial Crisis, with growth of approximately 2.1% projected for 2017; meanwhile, its debt burden of around 64% of GDP is even lower than Germany’s. In addition, the Netherlands’ ratio of sovereign debt to GDP is declining, thanks in part to higher-than-expected tax revenue last year, and thanks also to the re-privatization proceeds from banks nationalized after the crisis.
The monetary policies of the European Central Bank are cause for some concern for the Netherlands; the Dutch and Germans have seen their own central banks “lend” huge sums to the ECB's central-payment system, known as Target 2 – actions that effectively bailed out the weaker euro-zone members. Yet since September 2016, the Netherlands has seen their surplus Target 2 balance deteriorate. This suggests that the EU is more sensitive to political developments than previously thought, and that the markets are trying to protect themselves from a populist surprise in the Netherlands’ elections.
In terms of the Netherlands’ tax system, we do not expect significant changes to be implemented; however, if anti-EU parties were to gain traction in a coalition, their anti-free-trade stance could cause corporate taxes to rise.
Markets must become less narrow-minded
The uproar over a proposed merger of two major postal services in the region suggests there may be underlying hostility toward other kinds of regional consolidation, which the Dutch marketplace has benefitted from in the past. As a result, some corporations in the Netherlands have sought to unwind their interests in other countries as they encounter an unwelcoming environment at home, which could make the Dutch equity market less dynamic.
Overall, the journey to the “United States of Europe” requires local or national sentiment to become less narrow-minded so that European consumers can access better services at better prices, and so corporations can benefit from the economies of scale that Europe offers.
Fixed-income investors should find that the Dutch government’s prudence is successfully keeping sovereign-bond supplies low, which should suppress yields and keep prices high. At the same time, investors in the Netherlands’ equity and credit markets will find that issues are driven more by strong international exposure than by the local economy – which, again, is doing well.
Key considerations for investors
Anti-EU sentiment in the Netherlands did not significantly increase during the campaign, though anti-Islam feelings certainly grew. Yet despite rising support for populism, we believe there is little chance the Netherlands will leave the EU or the euro, since the Dutch are well aware that their strong economy is dependent on trade. If we consider the European Commission’s most recent Eurobarometer, which monitors changes in public opinion in the EU’s member states, the Netherlands is not the most euro-sceptic country. As the accompanying chart shows, the Netherlands is less skeptical of the EU than France, Italy and the UK, but more skeptical than Germany and Spain.
The Netherlands isn't the most euro-sceptic EU country
Source: Eurobarometer as of November 2016.
All told, although investors globally seem to have shaken off the political surprises of 2016 with incredible nonchalance, European elections have the potential to deliver more market shocks this year. However, the Netherlands’ markets have remained sanguine, which is probably due to the fact that they are underpinned by attractive credit fundamentals that have helped the country maintain its triple-A credit rating.
Globally, equity markets should now turn their attention to elections in France, Germany and possibly Italy, looking for any notable swings in sentiment. Investors should also watch closely for any resolution of the ongoing Greek debt problem, and for issues arising over the ECB’s Target 2 balances; either one would have political ramifications for the Netherlands given that its central bank has lent a significant amount of money to the peripheral countries.
Overall, the Netherlands will be one of the key parties involved in the debate over the future of Europe, helping to determine whether there will be more muddling-through, whether Europe will build a “coalition of the willing” or if we will eventually see the creation of a European super-state.
The highly valued US equity market has served many investors well in recent years, but Neil Dwane warns investors should watch for several factors that could put downward pressure on prices. At the top: Trumponomics troubles and growing inflation fears.
US bulls on eight-year run
The eight-year US equity bull market has time and again confounded its many detractors, helping US stocks remain among the top performers since the global financial crisis began. With such a history of strong results, it is easy to argue why many long-term investors should continue holding this asset class in their portfolios.
The markets had high hopes for Mr. Trump's policies, but his health-care bill's failure has curbed some enthusiasm
At the same time, the US equity market is highly valued – the current Case-Shiller price-to-earnings ratio of 29.8 is almost double its long-term average – leaving other investors to question whether this is currently the place to pursue growth potential and protect purchasing power.
US Equity Market Highly Valued
US price-to-earnings ratio is significantly higher than 30-year average
Source: Graham & Dodd CAPE/Schiller P/E
A US border adjustment tax could hurt corporate profits and economic competitiveness by boosting the dollar
What might make the markets pull back?
The Dow Jones Industrial Average has fallen about 1% from its all-time high, set earlier this year, and a growing chorus of market watchers is calling for an additional pullback. For our part, we have identified six factors that may encourage investors overexposed to
US equities to review their positions.
1. Trumponomics could provide limited lift Although the markets initially had high hopes for stimulative new policies from President Trump, the recent failure of his health-care bill has curbed some enthusiasm. Moreover, not all of Mr. Trump's remaining proposals are measures that have historically been proven to boost the US economy. Tax reductions for corporations and the wealthy tend to offer only a small lift, while new infrastructure spending and tax cuts for lower-paid workers have proved to be substantially positive economic multipliers only in the medium term.
2. Higher inflation + higher rates = An unpleasant surprise? US inflationary pressures could build much faster than the market expects, especially considering that the economy is almost at full employment and wages could soon start to rise convincingly. The US Federal Reserve is closely watching income and wage data – two data points that have historically been closely correlated. Depending on what it sees, the Fed could find itself "way behind the interest-rate curve" and move more aggressively, which would be an unpleasant surprise for the markets.
3. Trade could spell trouble for the US dollar If Mr. Trump begins implementing protectionist trade policies, there could be negative implications for the US dollar. The same is true of the failure of the Trans-Pacific Partnership, China's expansion of its "one belt, one road" initiative and rising oil prices. The imposition of a potential US border adjustment tax could also hurt corporate profits and economic competitiveness by further boosting the dollar.
4. Cost of servicing debt stands to rise The level of indebtedness in the US and around the world is significant, and it has been made affordable only because of extremely generous monetary policies. Even with a doubling of the US debt level in recent years, the annual cost of servicing it has remained around $425 billion. As interest rates move higher, Mr. Trump's financial wiggle room could diminish as the US government spends more to service its debt burden.
5. Demographics heading in the wrong direction Ageing populations are a challenge all over the world, and the US is no exception. Its economy could increasingly feel the drag of productive older workers leaving the workforce, replaced by a younger generation that is less well paid and more exposed to the forces of globalization. Moreover, by subjecting immigration to the whims of politics, America's famously flexible workforce could become less of an economic advantage as lower levels of immigration, a shrinking talent pool and reduced relocational flexibility take their toll.
6. Technology is doing less with more Despite some populists' assertions, it is not really globalization that hollowed out America's jobs market, but the rise of job-killing technology – a trend that is certain to grow as companies invest more in robotics and artificial intelligence. In addition, the multiplier effects of new technology and social media, where the US is a leader, are much smaller than those of previous industrial innovations – and much more disruptive to existing businesses. In the end, we may find that many high-tech innovations are better at creating vast wealth than vast employment.
Job-killing technology is on the rise as companies invest more in robotics and artificial intelligence
Key considerations for investors
Even in a world where low interest rates have inflated valuations almost across theboard, the US equity market is expensive. With an overvalued US dollar, the question may be when – and not if – the US equity market will pull back before starting a new cycle. With this in mind, here are several investment approaches to consider.
- Keep an eye on Asia: China, India and Indonesia offer the prospect of sustainable economic growth, as billions of people move toward middle-class careers.
- Monitor reforms in developing nations: Structural reforms provide investors with strong signals about the potential for future returns.
- Guard against interest-rate sensitivity: US bond markets are already shorting 10-year US Treasuries in the hopes of higher rates.
- Follow the money: Many US corporations are already buying attractively valued assets in Europe and Asia.