The “make or break year” for the European Union (EU) and the common currency will still pass without any significant disruption, but the result of Germany’s national election may be problematic for the EU.
As expected, Angela Merkel won a fourth term as Chancellor and will now seek to stitch together a workable governing coalition comprised of her centre-right Christian Democrat Union party, the pro-business Free Democrats, and the left-leaning Greens.
However, Merkel’s victory was blemished by post-war low election results from current coalition partner, the Social Democrats, and the entry of the far-right Alternative for Germany party, which captured 13% of the vote, into the German Parliament. Alternative for Germany campaigned on a fervent anti-immigrant and anti-euro stance. It marks the first time in more than 60 years that a far-right party will hold seats in Germany’s Parliament.
As a result, the battle continues for the long-term fate of the Europe project and the future of the single market, the common currency, and free labour mobility.
Forecasts of EU’s End Proven Wrong
At the beginning of the year, many pundits were drawing a straight line from the UK’s June 2016 Brexit vote to last November’s U.S. presidential election victory by Donald Trump to early 2017 victories for the anti-Euro parties in Austria, The Netherlands, and France. Nationalism and populism were said to be all the rage. Such forecasts, however, proved to be less than prescient.
In each instance, the pro-EU candidate won. France’s battle for the soul of Europe saw Emmanuel Macron and his pro-Europe, pro-business En Marche! party defeat Marine Le Pen and the far-right National Front by a two-to-one margin. At the time, we called an all-clear on European politics and implored investors to begin appreciating the sound economic recovery taking place across the continent. European financial markets have not disappointed. The MSCI Europe Index is up 23% year-to-date in U.S. dollars, outperforming the S&P 500 by more than 950 basis points as of Sept. 22.1
The German election did not buck the pro-Europe trend but was a clear setback. Europe’s political environment is evolving but it has not evolved to a level where we expect economic policy changes in the near to medium term that could undermine the cyclical trends. Nonetheless, the case for further pan-European economic consolidation has certainly weakened. As Barack Obama said in his last official visit to Greece as president, "History does not always go in a straight line."
On the other hand, with inflation well contained, the European Central Bank (ECB) is likely to remain supportive, irrespective of the policy front. In a perverse way, the German election result is likely to be supportive for the European economy and financial markets. Remember, the biggest concern of late has been the strengthening euro and its potential headwind for European exporters. Chancellor Merkel’s poor election showing and her diminished mandate weakens the euro, decreasing the near-term economic growth risks.
Why We Still Like European Equities
The upshot is that our view on European equities has not changed. We still favour European equities, given ongoing ECB policy support, the potentially weaker euro, and the enduring economic expansion. In fact, the European economy and European companies are among the biggest beneficiaries of the synchronised growth taking place across most regions of the world today, in my view.
The longer-term political issues remain but, over time, we still expect a more integrated EU rather than a trading bloc that comes apart at the seams. Remember, the Europe Project is only seven decades old.
As the Germans say, “Aller anfang ist schwer”: All beginnings are hard.
- ^Source: Bloomberg 09/22/17.
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