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What European Elections Mean for Stocks

Stocks fell Monday as concerns over political upheaval in Europe unsettled investors. And this volatility may continue even after ballots are cast in upcoming elections, advisers say.

The sudden resignation of the Dutch prime minister Monday, coupled with presidential election politics in France and Greece, heightened fears that a shakeup in leadership could upend efforts to address the European debt crisis. Politicians and parties opposed to the austerity measures favored by Germany appear to be gaining momentum, advisers say. If new leaders reversed course and opposed the belt-tightening policies that had been a condition for bailout funds, equity markets will suffer, advisers say. “For investors, that would be taking us all the way back to square one,” says Paul Christopher, chief international strategist for Wells Fargo Advisors.

In France, the concern among some advisers is whether socialist candidate François Hollande, who favors spending more to boost economic growth, could beat out President Nicolas Sarkozy, who sides with Germany’s approach of cutting costs in order to control the debt level. In the Netherlands, another big supporter of Germany’s austerity measures, Dutch Prime Minister Mark Rutte resigned after leaders were unable to agree on budget cuts. Party officials are calling for elections to take place soon.

Continued political uncertainty could lead to more downgrades or — in an extreme scenario — force some countries out the euro zone completely, says Ethan Anderson, chief investment strategist with Rehmann Financial. Such a collapse could send yields higher on government bonds, increasing borrowing costs and making a recession more likely. And that could lead to a selloff in stock markets as investors make a dash to safer assets, advisers say.

To be sure, the austerity measures in euro zone countries could continue regardless of who gets elected, advisers say. And a selloff in government bonds and stocks could force leaders to go along with Germany’s cost cutting approach — even if they don’t agree with it, says Doug Cote, chief market strategist for ING Investment Management. “The markets will punish any behavior that makes the country look worse,” says Cote. Some investors also say threats coming out of Europe are milder today than they were a year ago. Support from the European Central Bank reduced the risk of widespread bankruptcies from European banks, says Christopher. And economic improvements in the U.S. also make the domestic economy better prepared to handle any weakness in European markets, he adds. “The risks are still out there but the probabilities are much less than they were,” says Christopher.

In the meantime, some investors are taking some cautious steps to prepare for prolonged uncertainty. Because the U.S. is expected to grow at a more stable pace than Europe, Anderson says investors should buy more U.S. stocks than international stocks. Christopher of Wells Fargo is cutting back exposure to commodities like base metals and agriculture, which could see prices drop due to the weakness in the European economy. In equities, he is balancing aggressive sectors like industrial and material with defensive sectors like utilities.


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