German Election: Merkel Weakened – Heightened Uncertainty
Angela Merkel wins fourth term. Focus now turns to the coalition she needs to forge.
German voters have given Angela Merkel a fourth term in office, making her only the third chancellor after Konrad Adenauer and Helmut Kohl to have been elected a fourth time.
Without an outright majority, Angela Merkel's next task is to form a coalition. As things stand, we believe that a coalition between the CDU/CSU, the pro-business Free Democrats (FDP) and the Greens is the most likely eventual outcome. Nevertheless, forming that coalition may well be a long and drawn-out process. It took Ms. Merkel nine weeks to finalize her coalition in 2013, and this time may take even longer as the re-entry of the FDP into the Bundestag broadens the coalition options. As a result, specific announcements on policy priorities are unlikely to materialize before late this year. The fact that the AfD has entered parliament for the first time should not have a significant effect on the coalition talks.
Watch our Global Chief Investment Officer Michael Strobaek discuss the implications of the German election results for the European Union:
Sustaining the Franco-German Alliance
Much of Ms. Merkel's election success can be attributed to Germany's strong economy in the past years. Moreover, notwithstanding attacks on her "open door policy" for refugees in 2015, she has over the past years on the whole projected stability of leadership in the face of many global and regional challenges and crises. On the economic front, German employment has increased steadily since the financial crisis, leading to strong domestic expansion. As a result, the German economy has been growing for 12 straight quarters (as of Q2 2017). In addition, it has performed highly successfully in external trade, albeit in part due to the weakness of the euro. The strong economic and political standing should of course continue to benefit Germany going forward.
The re-election of Angela Merkel is equally, if not more important for the future of Europe. The strength of the AfD suggests some expectations regarding the deepening of European integration are overdone, but Ms. Merkel's re-election should continue to stabilize the key Franco-German alliance, particularly at a time when the United States is striving to focus more on its own strengths. Furthermore, it provides a promising basis for the implementation of some reforms, especially in the Eurozone. Key areas where we expect reform efforts to focus on include security cooperation and infrastructure, the financial system and investment in technology and high value-added sectors to increase competitiveness.
Not a Game Changer for Markets
Overall, despite the rather weak performance of the leading parties and uncertainty over the future coalition, the elections are not a game changer for markets. It seems unlikely that the remaining political risk premium in Europe will retreat in the short term. The entry of the anti-European AfD in the Bundestag may even add somewhat to the risk of intensified political antagonisms in Germany, but the traditional German parties are unlikely to engage with the far-right any time soon. The EUR has already appreciated significantly in recent months despite the continued monetary policy divergence between the US Federal Reserve and the European Central Bank (ECB), and so it could see some retracement. We keep our neutral view on the US-Dollar versus the Euro and Swiss Franc over 3 months.
Positive on German Equities, Neutral on German Bonds
Looking at equity markets, we feel comfortable with our positive stance on both European and particularly German equities. The new likely three-way coalition including the business-friendly liberals is, at the margin, beneficial for the asset class, with German domestically oriented stocks seen as doing well on the expectation of larger fiscal spending and demand-boosting policies. This should be particularly true for infrastructure and defense-related stocks.
Aside from the political backdrop, our positive view on the German equity market is based on the premise that 1) earnings growth and valuation are supportive and 2) the macroeconomic backdrop remains solid. As for fixed income, peripheral spreads may widen slightly on the strength of the AfD, but we expect the prospect of larger government spending and marginally lower taxes expected under the future government to weigh on German bonds, but probably not lead to large swings. A much more decisive factor for German bonds in the next few months are the ECB's discussions about the future of its asset purchase program. With valuations close to expensive, we currently are neutral on German bunds at the European level and maintain this stance given the election outcome.