Merkel’s Murky Win

German Chancellor Angela Merkel might not feel like toasting so heartily after Sunday's results: Photo by Joerg Koch/Getty Images.

German Chancellor Angela Merkel won a fourth term Sunday as her Christian Democratic Union (CDU) won the most seats in Parliament, but media coverage hardly makes it feel like a victory. The CDU and its Bavarian sister party, the Christian Social Union (CSU), won just 33% of the vote, 8 points behind its showing in 2013. Things were even worse for the Social Democratic Party (SPD), the CDU's outgoing coalition partner: It won just 20.5%, its worst result since WWII. Meanwhile, the far-right euroskeptic Alternative for Deustchland (AfD) matched the upper end of its polling projections, winning 12.6% of the vote. As Merkel and other party leaders hunker down ahead of coalition negotiations, headlines are busy parsing what it all means. As usual with elections, most of the implications are sociological and largely disconnected from capital markets. For stocks, we believe the only thing that really matters is this: Germany probably gets more gridlock, keeping legislative risk low and extending Europe's year of falling uncertainty.

Exhibit 1 shows the official share of seats each party won. It differs a bit from the stats in the preceding paragraph, as parties must win 5% of the vote to enter Parliament-so the seat tally is adjusted for the 5.1% of the vote won by everyone's favorite category, Other.

Exhibit 1: Parliamentary Pie

Source: DPA-Infocom, as of 9/25/2017.

The last coalition government still has a slight majority, but there is a teensy problem: The SPD has already said it won't partner with the CDU. While this might seem like an odd move-who doesn't want power?-it makes sense. Being the junior partner in a coalition government isn't quite political suicide, but it rarely leads to success at the next election. The SPD joined Merkel's coalition after coming in second in 2005 but lost 79 seats in the 2009 election. Her partner in that second term, the pro-business Free Democrats (FDP), was decimated in the 2013 contest. This isn't just a Germany-only phenomenon: Joining a coalition with Britain's Conservative Party in 2010 practically killed off the Liberal Democrats. They're still trying to bounce back. SPD thinks it will probably win more credibility for 2021 (or whenever) if it sits in opposition and positions itself as a viable alternative rather than a willing participant in CDU policy.

No other party has enough seats to form a two-headed coalition, so it looks like Merkel is going to form Germany's first-ever three-party national government. AfD is likely out, as a partnership would prove toxic to voters on both sides. Ditto the Left, which is basically the remnants of the old Communist Party. That leaves the FDP and Greens, whose inherent leftism is more socially acceptable. Because German pundits love coining snappy names based on political parties' colors, this is now known as the Jamaica Government. Not because Jamaica has a center-right/libertarianish/green coalition, but because black, yellow and green are the colors of its flag.^[i]

The Greens and FDP have loosely said they're willing to join with the CDU, but that doesn't mean they'll form a coalition quickly or do much once in office. Coalition talks usually take time in Germany. In 2013, they took 86 days. Considering there isn't a ton of ideological overlap among all three parties-and the FDP, Greens and CSU are already busy drawing red lines-nailing down the final agreement probably takes time. And talks might fall through, forcing Merkel to try sweet-talking the SPD.

Regardless of the government's final makeup, the likelihood of radical legislation seems low. The CDU, FDP and Greens are against immigration limits, the CDU and FDP don't want a ton of infrastructure investment, and it seems only the Greens want to ban all coal-fired power plants. We believe the eventual coalition should prove unable to pass sweeping legislation-watered-down bills are probably all it will be able to muster.

German stocks should be fine with this outcome. When governments can't do much, they can't create many winners and losers by redrawing property rights or regulations-and stocks generally dislike major change. Hence, gridlock is generally bullish. Since the 2013 election, German stocks are up 25.6%, just about even with eurozone stocks.^[ii] This time, people worry about AfD having 94 seats in the chamber (out of 709), but that still makes them a noisy fringe party with little to no legislative influence. They can talk a lot, but that's about it. Their presence might heighten gridlock, but it seems unlikely they tug policy in a more euroskeptic direction. Particularly if, as political analysts posit, their showing was a protest vote, not an anti-euro surge among Germans.

Overall, this is just one more milestone in Europe's year of falling uncertainty. As the Dutch, French and UK elections came and went, the political fog slowly cleared, letting investors better see Europe's strong economic fundamentals. Even in the Netherlands, which still doesn't have a government, people have moved on. They probably do the same in Germany as coalition talks heat up, and in Austria next month. We expect German and eurozone stocks to keep tuning out sociology and grinding higher.

[i] Source: Cool Runnings.

[ii] Source: FactSet, as of 9/25/2017. MSCI Germany and MSCI EMU Index returns with net dividends, 9/20/2013 - 9/23/2017