Making Sense of Catalonia

On October 1, following a widely watched political spat, voters in Spain's Catalan region went to the polls in an independence referendum and elected to leave Spain-despite Spain's government and constitutional court declaring the vote illegal and Spanish police attempting to deter it. The vote ratcheted up investors' uncertainty, and Spanish markets fell in the ensuing days as headlines called it Spain's biggest constitutional crisis ever (Exhibit 1). Some even claim it threatens the eurozone. We think these accounts are vastly overblown. A small region of a country seeking secession is far different than an entire country seeking secession from the eurozone. Regional disagreements like this occur frequently across Europe-Spain has a rich history of them. Continued volatility in local markets wouldn't surprise, but eurozone stocks have barely budged-and global stocks are even less likely to see much impact.

Exhibit 1: Spanish vs. EMU Market Performance

Source: FactSet, as of 10/12/2017; MSCI Spain and MSCI EMU returns with net dividends, 9/29/2017 - 10/12/2017.

The squabble isn't particularly new. Catalonia, a semi-autonomous region of Spain, has long had an avid independence movement (as does the tiny Basque region), which has perked several times during this bull market. Catalan regional leaders claim independence is justified by an unfair distribution of tax revenue. Catalonia-home to Barcelona-is a large slice of Spain's economy, but it doesn't control the allocation of tax revenue generated by the region. The Spanish government redirects some of this revenue to other regions, upsetting Catalan leaders-particularly as the entire country swallowed austerity during the debt crisis.

Because Spain's constitution establishes "the indissoluble unity of the Spanish nation, the common and indivisible country of all Spaniards," numerous Spanish court rulings since the end of Francisco Franco's dictatorship have declared secession unconstitutional. These rulings include the constitutional court twice banning a November 2014 independence vote, which went ahead anyway as a nonbinding resolution. This time around, in the six months before October 1, Spain's courts declared the vote illegal three times.

Prior to the vote, thousands of national police confiscated ballots and, on voting day, police clashed with separatists, hospitalizing nearly 900 people. But Catalan leaders persisted, holding the vote despite the show of force. The result: 90% of votes cast-roughly 2 million of 2.3 million total votes-were in favor of independence.

However, this is only about 40% of Catalan voters, highlighting the core issue: Voters who didn't favor independence were likely less motivated to vote in an election the central government deemed illegal, for fear of lending it legitimacy. The same likely happened in 2014, when the nonbinding measure passed with 81% of the vote on turnout of just 35%. Additionally, the central government didn't give Catalan election officials access to the voter rolls-there was little preventing voters from casting duplicate ballots. So while the international community and EU decried the Spanish central government's display of force, every major country agrees the referendum was illegal and has no domestic or international standing.

Afterwards, many expected Catalonia to declare independence on October 10. But Catalan leader Carles Puigdemont balked in a murky statement, perhaps (in part) swayed by the region's two largest companies, Caixa and Banco Sabadell, deciding to move their headquarters to other regions. On Wednesday, Spanish Prime Minister Mariano Rajoy gave the region five days to clarify its intentions, threatening to revoke Catalonia's autonomous status if it persists with its independence bid.

While the situation is rapidly evolving, Catalonia seems likely to jockey for more regional autonomy. Any meaningful move toward independence at this point is unlikely. Should those chances increase, they should be highly publicized, allowing broader European and global markets to adapt without derailing the bull market. Ultimately, this is a localized issue-and a legal issue, not an economic one. It is extremely unlikely Spain or the EU will permit a path to Catalan independence, and Catalan leadership needs EU support to move forward. This may linger in Spain's politics and courts for some time, but it shouldn't spill over into Spanish or European stocks.