Polls, GDP Data Set Stage for Germany’s Upcoming Federal Election

With Afghanistan and Delta still hogging most headlines in the US Tuesday, there was little new for investors to mull over. Enter Germany, which delivered a one-two punch of news: more details on Q2 GDP and the latest election polling, which put outgoing Chancellor Angela Merkel’s Christian Democratic Union (CDU) a hair behind its main opposition (and current coalition partner), the Social Democratic Party (SPD), for the first time in 15 years. That development isn’t mere trivia, as Germans go to the polls in five weeks. Some argue the election could have big economic consequences, as Germany’s main parties have disparate views on public spending. But overall, in our view, the status quo likely continues economically and politically, which is just fine for German stocks.

To understand the election’s alleged fiscal implications, it likely helps to dive into GDP first. German Q2 GDP grew 1.6% q/q (6.7% annualized), a whisker above the initial estimate of 1.5% q/q.^[i] In most countries, GDP revisions aren’t terribly newsworthy, but Germany is one of a handful that doesn’t release a detailed breakdown until the second estimate. Those details, which showed consumer spending leading the charge with a 3.4% q/q rise, confirmed the Federal Statistics Office’s earlier observations that services did the heavy lifting while global supply chain chaos hampered manufacturers.^[ii] Yet in heavy industry, it wasn’t all bad news. Business investment in capital equipment eked out 0.3% q/q growth, and exports rose half a percent.^[iii] So, following the pattern in other developed nations, supply shortages and shipping delays remained a surmountable obstacle in the quarter.

The lone category to contract was collective government consumption, which refers to spending in broad areas like defense and public safety (versus spending on individual services, including education, housing and health care). Total government spending still grew, but the -1.5% q/q drop in collective spending dragged down the federal government’s broader contribution. That might not ordinarily be major news, but collective government consumption is the category where Germany’s big COVID relief spending showed up in GDP in Q1 and Q2 2020. It fell in Q3 2020 as the economy reopened and private businesses resumed driving economic activity, but as new restrictions emerged and lingered in late 2020 and early 2021, the government amped up its response again. Now, with the country reopening once more, it appears officials are once again stepping back.

Politicians are deeply divided on what to do next, and that debate is front and center in the election campaign. Germany has a constitutional deficit cap, which normally limits the degree it can dip into the red to spend big. The government suspended it temporarily to deal with the pandemic, but now the CDU wants to reinstate it and get back to the pre-pandemic norm. Tuesday’s news that Germany’s public deficit soared to €80 billion—or 4.7% of GDP—in the year’s first half, which is the biggest shortfall since 1995, heightened calls for fiscal discipline in some quarters. But the SPD and Green Party—not to mention a large segment of the global financial commentariat—is calling for more spending, arguing Germany needs big fiscal stimulus. Not just to steer the economy through the global supply disruptions, but to shake off the slow growth that marked the 2010s. Some argue German stimulus is crucial globally, lest domestic demand sag and Germany leech money out of the rest of the world with giant trade surpluses.

As a result, many see the next election as make or break for fiscal policy. A coalition led by the CDU, they argue, would return the country to belt-tightening, while the SPD and Greens would turn the spigots loose. That, in a nutshell, is what made the opinion poll showing the SPD leading the CDU by a smidge such big news. It put the SPD at 23%, the CDU and its Bavarian sister party (the Christian Social Union, or CSU) at 22% and the Greens at 18%, with the pro-business Free Democratic Party (FDP) and nationalist Alternative for Germany bringing up the rear.^[iv] While this is just one poll, the gap between the CDU/CSU and SPD has narrowed considerably over the past year. According to Politico’s poll tracker, the CDU/CSU polled at 36% in late August 2020, versus 18% for the Greens and 16% for the SPD. That was in the afterglow of the summer 2020 reopening, before the successive lockdowns dampened everyone’s spirits and raised frustrations with Berlin.

Theoretically, those frustrations would apply to both parties in the coalition. But the SPD’s candidate for chancellor is Olaf Scholz, finance minister in the outgoing coalition. He was the architect and administrator of Germany’s COVID relief packages, giving him a popularity boost. Meanwhile, the CDU’s candidate, Armin Laschet, is struggling to rehabilitate his image after being caught laughing at a visit to one of the towns hit worst by severe flooding last month. Rumors that the CDU might drop him from the ticket in favor of CSU leader Markus Söder, who is rather more popular, haven’t helped. Meanwhile, Green Party leader Annalena Baerbock has also hit tough sledding over a couple of scandals. But campaigns matter, and polls this far out are baselines, not projections.

With that said, the polls do help set some broad expectations. Chiefly: No party looks at all likely to win an outright majority. Forming a government will require a coalition of two or (as looks increasingly probable) three parties. Regardless of which party wins a plurality, coalition building probably takes a lot of time and haggling, with many false starts. Last time, even though the CDU/CSU had an incumbent coalition with the SPD, renewing that arrangement took almost half a year as Merkel tried other combos first. This time, with divisions even deeper and polling even tighter, there is every chance of a long stalemate and, potentially, fresh elections several months later.

If a coalition government does emerge, regardless of who participates, it probably torpedoes everyone’s major campaign pledges since, in most potential outcomes, there is very little ideological alignment. The Greens and SPD may agree on more public spending in principle, but finding common ground on the recipients won’t be easy—to say nothing of a third party dampening their spending plans. Similarly, a coalition of the CDU/CSU, FDP and Greens might bring a smattering of watered-down spending on feel-good environmental items, but it would be a far cry from the latter party’s full ambitions. Other potential groupings would hit similar divides.

In our view, all these potential roads arrive at the same destination: gridlock. People tend to hate gridlock—the inactivity and constant squabbling can grate. But markets generally like it, especially in developed nations, as it reduces legislative uncertainty. All new laws have the potential to create winners and losers, which can weigh on sentiment and risk-taking if governments are active. But a government that can’t do much can’t radically alter property rights, giving businesses and households more latitude to plan and invest. Markets realize this and price it in, even if society never consciously does.

Gridlock has reigned in Germany for about a decade, ever since Merkel’s coalition with the FDP weakened during the eurozone debt crisis. The ensuing coalitions with the SPD accomplished little, with last year’s COVID relief packages the lone exception (a fact that held true globally). German stocks haven’t minded, rising 121.0% over the past decade.^[v] That is behind the MSCI World Index, but that comparison has considerable skew from the US’s huge weighting in Tech and Tech-like stocks. Remove that from the equation, and Germany is beating the rest of the developed world, as the MSCI World Ex. USA Index is up just 104.7% over the same stretch.^[vi] Gridlock doesn’t solely explain the gap, but we think it is part of the answer.

In short, we think post-election and post-pandemic Germany will look a lot like the status quo that reigned before 2020, regardless of which party helms the government. Gridlock and steady, services-led growth were a-ok for stocks before, and we doubt that changes in the foreseeable future.