• European stock markets tremble on political turmoil

• Fears of a potential debt crisis further darken outlook

• Strong US economy and tech dominance emerge as headwinds

 

Markets dislike uncertainty

European equity markets took a hard beating in the aftermath of the European Parliamentary elections, which showed an overall rise in far-right parties’ popularity. In France, the results forced the President Emmanuel Macron to call a snap election, triggering a strong selloff in the CAC 40 index.

In general, political uncertainty increases stocks’ risk premium, but this time things seem to be even worse. The prospect of a far-right government in the second-largest economy of the continent could produce effects similar to Brexit in the UK or Trump politics in the US. Considering that the EU is barely growing and the German economy is not in its best shape, a recession does not seem to be a far-fetched scenario.

Moreover, Europe’s far-right parties have been largely against the military and financial support in Ukraine. Hence, the rightward shift in Europe could cause tensions between the EU and the US, which could emerge as an additional risk factor.

Another debt crisis in sight?

Besides political risks, a far-right majority in France could lead to the country’s fiscal derailment. Should Le Pen attempt to pursue her expansive and protectionist fiscal agenda, the country could face a crisis like the one Liz Truss’ policies ignited in the UK in 2022.

On that front, the European Commission is expected to put France into an excessive-deficit procedure (EDP) to prevent politicians from stating populist claims as the country’s fiscal position has deteriorated significantly in the past few years. France is already running a deficit of around 5% of GDP, while its debt-to-GDP ratio is around 110%.

Already in May, S&P credit rating agency downgraded France’s long-term credit score to AA- due to the deterioration of its budgetary position. Unlike in the US, a crisis in one country of the EU can have huge spillover effects. Therefore, the risk of bond yield spreads widening in the periphery is significantly high, applying downward pressures in European stocks.

US outperformance and tech dominance weigh on European stocks

Amid the political turmoil in Europe, risk-seeking investors could search for stock exposure on the other side of the Atlantic. The US economy has been more than resilient in the past two years, in a period when Europe has been stagnating. This trend is more likely to persist on the back of the political and debt situation that the EU is currently facing.

Furthermore, the relentless rally observed in equity markets is largely driven by the AI mania as just a handful of tech stocks have been doing all the heavy lifting. Therefore, the European indices are poised to underperform for structural reasons given the scarcity of tech stocks and their tilt towards value-oriented companies.