Angie, when will those clouds all disappear?

In case you missed it, German Chancellor Angela Merkel—“Angie” as she’s so affectionately called—won reelection on Sunday to form a new coalition government with the Free Democrats (FDP).

 

Merkel’s conservative party, the CDU, together with their Bavarian Christian Social Union (CSU) allies, garnered 33.8% of the popular vote, to beat out her most significant challenger Frank-Walter Steinmeier of the SPD, which collected 23%.  The FDP attained 14.6%, and with it as coalition partners of the CDU/CSU a majority in the Bundestag (Parliament).

 

As we highlighted in our German election preview post on 9/25, “Showmanship”, the CDU/CSU coalition campaigned under:  tax cuts of 15 Billion EUR for the highest and lowest income tax brackets and reduction in the corporate tax (currently around 30%) and support for nuclear energy, while the FDP espoused special attention to small and medium-sized enterprise (Mittelstand) and a 3-tier flat tax.

 

While campaign promises don’t always materialize, we’re bullish on Merkel’s pro-business platform with the FDP, and believe that her continued leadership (ex the center-left SPD) will buoy equity markets and lead the German economy that saw modest growth of 0.3% in Q2 (Q/Q).  Concerning the energy sector in particular, Merkel has not ruled out the need to work with the Russians for supply and intends to extend legislation that would phase out nuclear plants by 2020. Today, German utility names (like E.ON; RWE; EnBW; and Swedish-based Vattenfall) surged on her victory. 

 

Still up for question is the ability of tax cuts to stoke the economy, which was a major component of her campaign.  While cash for clunkers was a highly successful stimulus program, it’s now rear-view and the government is facing a public debt next year to the tune of 6% of GDP. While this number is manageable, [in context Spain just announced its figure of around 10%, which incidentally prompt the government to raise the VAT tax to 18% over the weekend]—and while its Eastern European peers are even more extended, fiscally conservative Germans will be highly skeptical if Merkel does not reduce the state’s debt in the next 18 months. Further, a rise in unemployment next year could provide a headwind to Merkel’s credibility.

 

For now, we’re still bullish on the country’s fundamentals. The low CPI and interest rate environment has encouraged spending and anecdotal reports suggest credit is flowing back into the market.  This trend of low inflation was confirmed today by the Federal Statistical Office that reported initial CPI for September to decline 0.3% year-over-year and -0.4% month-over-month (See Chart Below). In the near term we see this as a net benefit to consumers, driven particularly by the lower energy prices.

 

With last week’s German (Gfk) consumer confidence rising to a 16th month high (and improving over the past 6 months) along with business confidence (Ifo) showing it highest reading in a year, confidence projections look bullish in the intermediate term.  We’ll be monitoring Factory Orders for confirmation that the export-giant is finding global buyers to propel growth. 

 

While German stocks, from banks to retailers, gained handsomely today, the DAX, as a reflection of the broader German economy, has been a slow moving force year to date, trading 100-300 bps better than the S&P500 for much of year. We like Germany, which we’re currently long via EWG, as a defensive name for positive (moderate) growth.

 

 

Matthew Hedrick
Analyst

 

Angie, when will those clouds all disappear? - a1


 


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