Political turnover in Europe: Still searching for a solution to the debt crisis

Recent election results in France and Greece created yet another major political turnover in the euro zone. In France, incumbent president Nicolas Sarkozy lost to challenger Francois Hollande, who intends to balance the austerity measures imposed by the European Monetary Union (EMU) with growth. In Greece, both major parties faced losses. The socialist Pasok party that led negotiations during Greece’s first bailout, ranked third, while the conservative New Democracy party, which also has supported the austerity measures imposed by the EMU, ranked first. Yet, the combined votes of the two parties did not exceed a simple majority, as Greek voters also seem to have concluded that austerity alone is not able to resolve the country’s debt crisis.

Since the height of the financial crisis, 10 separate countries within the euro zone have ousted their incumbent governments, either in scheduled elections or in unscheduled emergency votes (source: Bloomberg). In each case, the results of the elections have reflected voters’ attempts to find a new direction as they have discovered the depths of, or looked to resolve, their respective debt crises. It is within this light that we view the recent elections in France and Greece.

In our opinion, the recent election results reflect the desire of voters in both countries to take a more balanced approach toward ending their individual crises. French and Greek voters, in our view, made a clear statement indicating their beliefs that austerity alone is not sufficient to solve their fiscal issues and that growth is as important, if not more important, than spending cuts alone. Voters in Germany and Italy soon will have their own opportunities to make statements on how to end the existing debt crisis, as elections within both countries are scheduled for 2013. Of course, additional unscheduled elections could also take place across a range of euro-zone countries — Greece, for example, will now need another election in June since a coalition government won't be formed by the scheduled deadline.

Over time, we believe the elections in France, Greece, and elsewhere will slowly bring to light the varied dimensions and depths of the crises faced by countries across the euro zone. They could also differentiate the new European leaders, both by popular support and, of course, by the efficacy of their proposed solutions to the crisis. Yet, we also look at some of the central issues facing Greek and French voters most recently, and we believe that they highlight the types of critical structural issues that could continue to hurt these economies, and indeed those of many countries across the euro zone.

Namely, we believe that most economies within the EMU remain inefficient relative to the rest of the developed world — these countries’ public sectors remain too large, while their private sectors are less competitive in their labor productivity. It could take years for these countries to transition toward what we would view as a more sustainable market economy, as Sweden did in the wake of a similar crisis it experienced in the 1990s. For this reason, we believe that, on balance, European markets could continue to face downside risks for much of 2012 and thereafter.

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The views expressed represent the Manager's assessment of the market environment as of May 2012, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the manager's current views.

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