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Merkel Triumphs but Loses Her Coalition Partner 




A victorious Merkel seeks a coalition partner with the SPD, though negotiations may be lengthy and might unsettle markets. However, the strong likelihood of a Merkel-led grand coalition would prove positive for markets in the longer term.
By Neil Dwane, CIO Equity Europe, Matthias Born, Co-Head of European Growth Equities, and Ralf Walter, Senior Portfolio Manager.

Angela Merkel and the Christian Democrats emerged as overwhelming winners of Sunday’s federal elections, with the Christian Democratic Union/Christian Social Union (CDU/CSU) receiving 41.5 per cent of the vote – a swing of 8 per cent – compared with 25.7 per cent for the Social Democratic Party (SPD).

However, the CDU’s coalition partner, the Free Democratic Party (FDP), was decimated with only 4.8 per cent of the vote, its worst result since 1949, and is now out of the Bundestag (lower house). This leaves the CDU/CSU five seats short of a majority in the Bundestag and seeking a coalition partner for a majority in the Bundestag. While Merkel would probably have preferred to remain in a coalition with the liberals, thereby allowing her to continue running German domestic politics along similar lines to those of the past, we now expect a period of tough negotiations between the CDU/CSU and the SPD, resulting in a grand coalition which would have 67.2 per cent of the Bundestag.

A grand coalition could take some time to achieve

Negotiations between the CDU/CSU and the SPD could be concluded in a week or two but similar negotiations have taken considerably longer in the past. In 2005, it took 65 days to reach the grand coalition led by Merkel; in 2009, the CDU/CSU coalition with the FDP was agreed after three to four weeks – but was rushed through, in advance of the 20th anniversary of German reunification celebrations.

Short-term uncertainty; positive longer-term

In terms of policy, we hope, in coming days, to learn more about the nuances between the CDU and the SPD. While we believe markets are unlikely to be significantly shocked by the different shades of grey that will probably emerge over the next few weeks, the uncertainty created by the negotiations and the areas of compromise between the CDU and the SPD and the risk that building a coalition may take longer than the market hopes could unsettle markets in the short-term. However, as we’ve noted in our two previous special elections briefings, the strong likelihood of a resulting grand coalition government would be positive for markets longer-term.

Euro-Zone Policy

Major changes unlikely

We have previously highlighted that, while the CDU and SPD do not have very different views on the euro zone, the SPD is even more pro-euro than the CDU. A grand coalition government would, therefore, possibly be regarded by markets as positive for the euro zone. However, we do not expect major changes on euro-zone policy from a grand coalition government. Merkel has already relaxed euro-zone policy on austerity and focused more on growth initiatives than previously, a move in the direction of SPD policy. We expect Europe to get more of the same from Merkel, who is unlikely to ease the pressure on Europe to restructure and become more competitive.

Getting the right mix of carrot and stick

The biggest paradox for Merkel will be that, before she went into electioneering mode in the spring, she spoke about the need for “more Europe”, with greater control going to Brussels, more fiscal unity and less flexibility over government budgets – a difficult sell for the French, Italians and others. The paradox arises because, in 2015-2016, she will have to deal with a UK that may want to leave the EU and will need not only to make “more Europe” more attractive and appealing to those already inside the euro but also define the way positively so that those less enamoured of Europe, especially the UK, stay in or even join the euro. The difficulty lies in getting the right combination of carrot – to shift France and the UK in the right direction – and of stick – to beat some of peripheral Europe with – and this is likely to prove quite a challenge for Merkel.

A lesson from the AfD

Some focus will now return to the German Constitutional Court decision on the review of the rescues in Europe so far, postponed until after the elections. To date, the Court has been supportive but restrictive on how much Merkel can pledge to the weaker euro-zone countries. Looking ahead, Merkel will need to be careful in terms of spending or giving more money to the periphery as the German electorate objects to further transfers of funds in the euro zone. This was illustrated by the success of the euro-sceptic Alternative für Deutschland (AfD), founded only six months ago, which won 4.7 per cent of the vote (compared with 3 per cent in the polls). The AfD received support from all sides of the political spectrum and this could be seen as a warning to Merkel not to increase German liabilities for foreign debt.

Added attractions of European equities following the elections

In previous reports, we have highlighted the attractions of European equities, among them:
Europe offers many strong companies and, with a good chance of a macroeconomic pickup in Europe, provides a good combination for the earnings outlook over the next 1-2 years.
European equities are undervalued; Europe has underperformed the US by nearly 40 per cent over the last 5 years.
Global and European investors are underweight the region.

Following the German election results, we can add:
After some weeks of uncertainty, the risk of an unexpected German election result has passed.
International investors know what to expect from Angela Merkel and that she will do all she can to sustain the euro and the euro zone.
The recent strength of the euro and the expectation that it will remain strong is positive from the perspective of international investors – particularly in light of how volatile certain currencies have been recently and the losses some investors have incurred in international investments through currency.

Domestic Policy

What a grand coalition might mean for domestic policy

After winning 41.5 per cent of the vote, the CDU clearly has more power than the SPD. However, to form a grand coalition, they will need to compromise in some areas where the SPD has different ideas, particularly as the SPD has a majority in the Bundesrat (upper house). Domestic policies rather than regional policies are likely to be subject to change, particularly areas like energy, health, tax and pensions policy, where a grand coalition could institute necessary and previously postponed reforms.

Energy: Germany’s energy transformation plan to switch to renewable energy has resulted in energy prices being too high and has put German industry at a strategic disadvantage. While there is no certainty that a grand coalition will revisit decisions like that of turning off nuclear power post the Fukushima disaster, many of Germany’s larger international manufacturers would clearly like the decision reviewed and changed. All parties realise that Germany needs to be competitive in terms of energy and, therefore, there could be policy changes in coming years, especially as the CDU and SPD have similar views on energy. In fact, there is speculation that a special Minister for Energy may be appointed.

Minimum wages: Here again, with not radically different views, the CDU and SPD could quickly reach agreement. While the CDU has already made some changes, it would need to move further in the direction of the SPD. Raising minimum wages would boost domestic consumption but it needs to be done carefully, so as not to reduce competitiveness.

Tax, employment and pensions: With the aim of running a budget surplus and with satisfactory unemployment levels in Germany, a prudent government is unlikely to be in favour of cutting taxes, in the belief that it’s not currently necessary. The focus on employment and pensions is likely to be about finding ways in which the population can be encouraged to provide more for their own pensions, to mitigate the longer-term tail liabilities the government currently carries. Fiscal initiatives could aim to position Germany to be fiscally stronger in 10 or 15 years’ time.
Source of all data: Allianz Global Investors, as at September 2013

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.



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