German chancellor Angela Merkel’s majority win in yesterday’s election was broadly expected, according to several investment professionals, although they argue the “devil is in the detail” when it comes to what the overall results mean for European equities.
The chancellor’s Christian Democratic Union (CDU) and Bavarian CSU parties secured 33 per cent of the overall votes, securing her fourth consecutive term in power.
However, this came as Merkel’s parties witnessed an 8.5 per cent fall from its showing in the 2013 elections. It was also the worst result for the CDU/CSU since 1949.
Merkel’s coalition partner, the Social Democratic Party (SPD), announced that it would go into opposition following equally lacklustre results. As such, the chancellor seemed likely to attempt to form a three-party coalition with the Free Democratic Party (FDP) and the Greens. 
Meanwhile, far-right populist party AfD saw significant gains, having won 12.6 per cent of the overall vote. This means it has become the third-largest political party in the German parliament, the Bundestag.
Wolfgang Bauer (pictured), who co-manages three bond funds at M&G Investments, said the losses experienced by the CDU/CSU were made all the more significant by Germany’s strong economic backdrop which should have been a tailwind for Merkel.
“Two factors might have played a key role: ‘Merkel fatigue’ – after 12 years in office many voters probably thought it was time for a change of management. Furthermore, her handling of the refugee/immigration crisis has alienated voters at the conservative end of the political spectrum,” he noted.
However, Bauer said the strong performance of the AfD was the most “striking” result of yesterday’s election.
“None of the other parties is going to form a coalition with them and AfD members of parliament are likely to be treated like political pariahs,” he said. “We have seen this happening in German state parliaments many times before.”
That said, Bauer believes there is likely to be two “indirect consequences” of the AfD’s heightened popularity. Firstly, he thinks political pressure on Merkel to alter some of her policies will increase.
“In the past, she has been willing to revise long-held positions (e.g., on nuclear power, the minimum wage, same sex marriage, etc.) when she felt that sentiment amongst voters was shifting,” Bauer explained. “In order to win back voters from the AfD she might change tack again, possibly turning more conservative, with a stricter stance on migration, EU centralisation and so on.
“Secondly, the success of the AfD at the ballot box might challenge the prevailing narrative, particularly since the Dutch and French elections, that anti-EU populism was on the decline.
“This could have implications for markets, which arguably have become somewhat complacent in this regard.”
Performance of indices in 2017
Source: FE Analytics
If populism within the EU does increase, the manager said this could pile pressure on the valuation of the euro which, in turn, would cause the risk premium for European corporate and government bonds to widen again.
He also noted that the Catalan independence referendum is on the horizon as well as the Austrian and Italian general elections which, depending on the results, could cause spreads to widen further.
Alex Brandreth, deputy chief investment officer and senior fund manager at Brown Shipley, agreed with Bauer that “the devil is in the detail” when it comes to the German election results.
He said the surge in the AfD’s popularity – as well as the fact that six parties are due to enter the Bundestag for the first time since 1953 – echoes the ‘vote for change’ seen during the UK’s majority Brexit vote, the election of US president Donald Trump and French president Emmanuel Macron.
“It does set a slightly concerning precedent with the Italian election on the radar early next year,” Brandreth warned.
“The developments overnight may dampen the recent strength in the European growth recovery of late and potentially keep the ECB from pulling the trigger to reduce simulative support.”
BlackRock Investment Institute’s strategist team believes the lacklustre election results for Merkel will slow down the Franco-German drive to encourage deeper eurozone integration.
While it expects the results to have a limited impact on financial markets, it warned that the momentum behind efforts to strengthen the eurozone could slow.
“A big question is whether the head of Germany’s finance ministry might switch,” it said. “Would Merkel’s offering this powerful position to the SPD bring the Social Democrats back to the [coalition] negotiating table?
“Such an outcome could soften Germany’s stance toward peripheral eurozone countries and cause an uptick in government spending.
“The European Commission has already called for greater public investment to boost Germany’s potential growth and spur economic activity elsewhere.”
The team said Merkel could now become more nervous on the prospect of supporting pan-European initiatives, such as Macron’s push for a centralised eurozone finance industry.
“We prefer European equities over government bonds and credit amid a sustained, above-trend economic expansion and a steady earnings outlook,” it explained.
“Companies with much of their cost base overseas should have some cover against a strong euro in the short term, we believe.
“We see scope for the US dollar to regain some ground against the euro as the Fed presses ahead with policy normalisation and US inflation looks ripe for a rebound.
“We believe core inflation in the eurozone is likely to stay muted, keeping the European Central Bank accommodative.”
Dylan Ball, executive vice president of Templeton Global Equity Group, is also optimistic on European equities over the longer term despite increased support for the AfD.
“We view this as just one election and think there are reasons to be optimistic from an investment standpoint,” he said.
“Several core euroland countries are approaching full employment, and with labour capacity starting to tighten, we’re starting to see wages rise.
“A widespread economic recovery in Europe should take the wind out of the sails of populism, because political activism has traditionally declined as more people begin to see their lot improving.
“Already we perceive European corporate earnings to be in the early stages of a recovery. If we look at the macro backdrop, unemployment across the eurozone is at eight-year lows, while manufacturing leading indicators are at six-year highs.”