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Whilst Germany waits to learn whether another lockdown will cancel Christmas, there is now one present under the tree: a new government, meeting incoming Chancellor Olaf Scholz’s goal of having an administration in place before St. Nick’s arrival. His Social Democratic Party (SPD) has completed coalition talks with the Greens and Free Democrats (FDP), and all three parties have blessed this so-called traffic light coalition (named for the parties’ colours of red, green and yellow, respectively). They will be sworn in Wednesday, sending retiring Chancellor Angela Merkel (proverbially) riding off into the sunset. Yet whilst the faces and parties in charge are changing, we think the new coalition’s economic agenda mostly extends the status quo. Political gridlock also appears to be getting an extension, as the ruling parties have very little ideological overlap. This has already watered down major initiatives, as the policies outlined in the coalition agreement are a shadow of the parties’ campaign pledges.[i] We think they could very well diminish further as lawmakers grind away at them in debate. In our view, for stock markets, it all adds up to not much happening, keeping uncertainty low—a political backdrop that, in our view, is beneficial for stocks and spans much of Continental Europe as 2021 closes.
The coalition’s leadership and policies shaped up as most analysts we follow expected. Christian Lindner, leader of the pro-business FDP, will take the post of finance minister. Green co-leader Annalena Baerbock will be foreign minister, whilst her counterpart, Robert Habeck, will be climate and economy minister. As for policy, COVID containment will probably dominate everything in the near term, with rising cases and a contentious potential vaccine mandate likely monopolising attention. Beyond that, at the Free Democrats’ behest, the coalition has pledged to leave the country’s constitutional deficit limit alone, which likely hampers any effort to materially increase public spending—potentially jeopardising plans to increase infrastructure and defense expenditures.[ii] The FDP secured a pledge to avoid tax hikes, further reducing fiscal wiggle room. It wouldn’t surprise us if arguments over spending deepened divisions within the coalition and gridlock. The FDP did cease opposing the SPD and Greens’ insistence on hiking the minimum wage to €12 per hour, but negotiations over how to implement that remain.[iii]
Energy plans could also cause friction, despite the apparent enthusiasm for them now. The coalition agreement includes a pledge to accelerate the phase-out of coal-fired power plants to 2030 instead of 2038, a big win for the Greens—although perhaps a weird pledge to hype amidst an energy crisis fuelled in part by unpredictable, intermittent generation from wind and solar.[iv] The plan includes a pledge to get 80% of power from renewables when coal is phased out, but it isn’t clear how that will work when the country also remains opposed to nuclear.[v] France, the UK and others are pursuing next-generation nuclear power technology known as mini-modular reactors in their push to reduce carbon emissions, but Germany is sticking with its decision abolish nuclear power after 2022.[vi] Considering a shortage of wind power contributed heavily to the present energy crisis, relying on wind and solar for 80% of the electrical grid seems like just a bit of an odd choice to us, making this area seem ripe for gridlock to throw sand in the gears.[vii]
For the most part, we don’t see the new government as radically different from the old one. During Merkel’s two most recent terms, Germany had a divided coalition that had little ideological overlap and moved gradually, avoiding radical change. Under Scholz, Germany will have … a divided coalition with little ideological overlap and a policy agenda that doesn’t appear to tee up radical change. In our view, it makes no difference to stocks that the leadership happens to now be centre-left instead of centre-right. Our research shows policies, not personalities, are what generally matter most to stocks, and two governments that can’t advance much differ little on actual policy grounds.
We think an internally divided do-little government should is likely to prove just fine for German stocks—as it has been under Merkel in recent years.[viii] Our research shows gridlock reduces the likelihood of redistribution and big changes to property rights. Whatever your personal opinion of such changes, when legislation creates winners and losers, behavioral finance theories suggest to us the losers hate it far more than the winners enjoy it, creating a net negativity that we think can weigh on stocks.[ix] Not only does gridlock reduce this risk, but we have found that whatever legislation does pass ends up being much milder than initial proposals, creating relief for investors—one recent example being the legislation passed thus far in US President Joe Biden’s first year in office. In our view, this is a positive for stocks not just in Germany, but throughout Europe and the developed world, where coalition and minority governments are the norm these days. Politics is just one driver for stocks, but there don’t appear to be major speedbumps on this front for now, in our view.
[i] “German Parties Seal Coalition Deal to Make Olaf Scholz Chancellor,” Laurenz Gehrke, Politico, 24/11/2021.
[ii] “German Parties Agree Coalition Deal to Make Olaf Scholz Chancellor,” Kate Connolly, The Guardian, 24/11/2021.
[iii] “Ready for Power: Team Scholz Promises a New Germany, Jenny Hill, BBC News, 6/12/2021.
[iv] “Europe’s Energy Crisis Underscores the Dangers of the Proposed Clean Electricity Performance Program,” Robert Bryce, Forbes, 13/10/2021.
[vi] “France, UK Bet on Mini Reactors in Bid to Solve Nuclear’s Cost Problem,” Peter O’Brien, France24, 26/11/2021.
[vii] Source: WindEurope, as of 6/12/2021.
[viii] Source: FactSet, as of 6/12/2021. Statement based on MSCI Germany returns with net dividends.
[ix] “Prospect Theory: An Analysis of Decision Under Risk,” Daniel Kahneman and Amos Tversky, Econometrica, Vol. 47, No. 2, March 1997, pp. 263 – 291.
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