Adiós to the EU?

With all the pixels spilled over last Thursday's Brexit referendum, some things happening on the Iberian Peninsula may have gotten overlooked. However, Spain's general election was kind of a big deal, given Madrid has been government-free for more than half a year. Besides its importance to the Spanish people, last Sunday's election also amounts to the only actual evidence to assess claims that Brexit may motivate other nations to follow suit-a potential domino effect threatening the EU itself. Though just one vote, Spain shows worries over voters rejecting the current status quo and political establishment are premature-something investors should keep in mind amid post-Brexit hysteria.

First, a primer on Spain's political scene: Sunday's election was necessary because officials couldn't form a government following last December's vote. For most of its democratic history, Spanish politics have been dominated by two major parties: the center-right People's Party (PP) or the center-left Spanish Socialist Workers' Party (PSOE). However, due to growing dissatisfaction with the political establishment, upstart parties have gained prominence recently, most notably, far-left Podemos and centrist Ciudadanos. December's parliamentary elections resulted in a hung parliament, for although the PP and PSOE won the most overall votes and parliamentary seats, both fell far short of the magic number necessary (176 seats) to form a government-they would have to form a coalition. The new parties (particularly Podemos) grabbed more seats than ever, yet it was mathematically impossible for either the left-leaning or right-leaning parties to form an ideologically unified government. After months of discussions and political wrangling, nobody could cobble together a workable majority, prompting Spain's King Felipe VI (largely a figurehead politically) to call for new elections in June.^[i] In the lead-up to June's vote, some speculated Podemos would follow its surprising December performance with an even better showing-perhaps even supplanting the mainstream PSOE as the party of the left.

Yet that didn't happen. (Exhibit 1)

Exhibit 1: Spanish Elections, June 2016 vs. December 2015

Source: El País and Fisher Investments Research, as of 6/29/2016. H/T FI Research Analyst Scott Botterman.

Once again, the PP was the leading vote-getter, picking up 14 seats from December's election. Contrary to some forecasts, Podemos, which partnered with the United Left (IU) to run as Unidos Podemos, didn't leap into second place. Instead, Unidos Podemos won the same number of seats as its members' combined total in 2015, while losing 1.2 million popular votes compared to Podemos and IU's combined December total. While a sizable drop in turnout explains part of this, even with about 1.3 million fewer voters hitting the polls, the PP still gained over 650,000 votes vs. its December total.

The PP will once again get first crack at getting 176 MPs' approval to form a government. Its improved performance has boosted Prime Minister Mariano Rajoy's leverage, though both the PSOE and Ciudadanos have said they won't agree to a Rajoy-led government. Contentious rhetoric aside, most want to avoid a third election, likely resulting in a minority government or a relatively unstable coalition. That spells gridlock, which makes it very unlikely the growth-enhancing reforms enacted in recent years are repealed. Yes, it means new reforms would face a tough road, but Spain is on much more sound economic footing today than in years past. Growth is among Europe's fastest, with GDP growing 3.2% in 2015 and 3.1% annualized in Q1 2016.^[ii] Gridlock likely wouldn't be problematic in Spain.

Spain's general election result shows why it is important to avoid extrapolating from one outcome, whether it's politics or a broader market-related issue. After Leave prevailed in the Brexit referendum, many speculated about potential contagion. Does Brexit represent a watershed moment in which Europeans begin rejecting the status quo and the broader union and similarly demand big change, with a "tsunami" of referendums from Paris to Budapest to follow? Will Brexit beget a "Quitaly"?^[iii] Will Prague "Czechout"? Does Vienna head "Outstria"? Will Slovenia tell the EU they are Soleavinya? We suppose it's possible. But presuming one group of people voting one way will promote others to do the same ignores a complex reality.

The Spanish results reflect this. While some suggest a Leave win would encourage voters elsewhere to lean euroskeptic or outsider, the opposite is equally possible. Perhaps spooked by the strongly negative global media reaction, Spanish voters gravitated toward the PP. The establishment presents a known quality (i.e., stability) in what many perceive to be an uncertain environment. Despite voter anger on issues like corruption and the appeal of a fresh start with outsider parties, Spain ultimately supported the known, warts and all, rather than go down an unknown route. We aren't saying every single EU country will behave in the same manner, and euroskepticism appears much stronger in other nations, but we already have a counterpoint to the narrative that Brexit will cause the EU to disintegrate. It is a possibility to consider, but a very distant one for now.

While Brexit has driven some uncertainty and market volatility recently, we remind investors that in the here and now, the bullish drivers existing before the referendum remain. Economically, the UK remains one of the developed world's strongest economies, and it is still a part of the EU today. Europe's economies, particularly the eurozone, are doing much better than perceived. Politically, governments are still largely gridlocked-a positive. Yes, votes matter, and their results can impact stocks-especially if the results produce more uncertainty, which knocks sentiment. But they are also just one factor markets price in-they aren't the only or even the most important one.