A Preview of Germany’s Election

Win or lose, German pols can follow up Sunday's election with a ride on the Ferris wheel at Oktoberfest. Photo by Christopher Wong.

Europe's year of falling political uncertainty takes another step Sunday, when Germans vote on their next parliament and chancellor. Incumbent Angela Merkel of the Christian Democratic Union (CDU) is seeking a fourth term, and public polls suggest she will succeed, with her party taking the most seats but falling short of an outright majority. The Social Democrats (SPD), her current coalition partner, are a distant second but several points ahead of smaller parties. Outside some foreign-meddling intrigue, there is more drama surrounding third place, as a smaller party could help form the next government. They are already jockeying for position. The free-market Free Democratic Party (FDP), for example, is suggesting they won't enter any coalition with Merkel if it cannot name a finance minister. While the possible coalitions are myriad, the probable result is political gridlock-a bullish development. In our view, Germany's likely legislative gridlock is a positive that adds to the eurozone's year of falling uncertainty-a reason to be bullish toward European markets.

At 2017's onset, many political analysts feared a populist wave washing over the Continent-particularly after 2016's Brexit vote and Donald Trump's surprising presidential election. Germany's populist answer is the far-right, euroskeptic Alternative for Germany (AfD) party. After failing to garner the necessary 5% of the vote to enter the Bundestag in 2013, AfD has steadily built up its representation at the local level. It looks poised to win a few seats in the Bundestag this year, and while it is still a minority party, some worried broader European populist momentum could boost AfD even higher.

However, German election results this year suggest that narrative is a bit off. In May, the coalition of the CDU and its Bavarian sister party, the Christian Social Union (CSU), won regional elections in Schleswig-Holstein and North Rhine-Westphalia, the latter being the country's largest state and a SPD stronghold-a major blow to those predictions of Merkel trouble. AfD, on the other hand, has experienced internal dissent and tumult-leading to leadership changes and sagging support-while other third parties like the FDP have gained in polls. These developments have helped chip away at the broader political uncertainty.

While Merkel's CDU/CSU coalition appears positioned to win the highest share of Bundestag seats, the government's final composition appears unsettled. One possible outcome is renewing the grand coalition between the CDU/CSU and the SPD, which would extend the past four years' gridlock. But smaller parties ranging from the FDP-the CDU/CSU's most natural coalition partner-to the left-leaning Green Party could also enter the picture, which could influence the degree of gridlock. For example, because the CDU/CSU and FDP are more ideologically aligned, in theory, their partnership could lead to a moderately more active government. That said, when they governed together from 2009 - 2013, it didn't lead to any major legislative changes. A renewed coalition could be similarly inactive-even less so, potentially, if the left-leaning Green Party is part of it. We don't know how the specifics will shake out, but whatever the outcome, coalition governments tend to be more gridlocked than single-party administrations, given their competing interests. While many believe this is a negative, this gridlock is good for stocks, in our view, as it prevents radical legislation. The probable lack of an outright majority should thus keep legislative uncertainty relatively low-an underappreciated tailwind in competitive, developed economies like Germany.

In our view, the passing of Germany's federal election is another domino falling in Europe's year of falling political uncertainty-a theme we have highlighted since 2017's outset. The resolution of the Dutch and French elections earlier in the year allowed investors to start moving on. The passage of other elections further reduces this political uncertainty. Besides Germany, Austria holds a presidential election in October, and Italy must hold a vote sometime before May 2018. As these elections get resolved, investors can focus on and appreciate other market drivers-like solid economic growth and rising corporate profits. This should allow investors to start warming up to a better-than-appreciated eurozone reality and bid stocks higher-a major reason we are bullish toward Europe.