How might markets react to the German election

A few shocks have emerged from the raft of elections across Europe over the past year or so. It began with the Brexit vote in June 2016, followed by the Italian referendum (December 2016), the Netherlands Parliamentary election (March 2017) and French Presidential election (April/May 2017). Now it’s Germany’s turn with the federal election on Monday 24th September 2017. In this report, we examine the German electoral system, the likely outcome, the effect on equity markets and some stocks worth keeping an eye on.

Overall, Europe seems to be seeing a shift to the right of centre, with a rise in popularity of the far-right parties. This seems to be down to the combination of the longest period of economic stagnation and the worst refugee crisis since the end of the Second World War. The far-right parties continue to be as fervently nationalistic as ever, but are now

being fronted by more charismatic politicians such as Marine Le Pen of Frances’s National Front or Norbert Hofer of Austria’s Freedom Party as well as Frauke Petry of Germany’s Alternative for Deutschland (AfD).

Over the last twelve months, European stock markets have been enjoying a good run. Europe’s leading blue-chip index for the Eurozone, the Euro Stoxx 50, has climbed from a level 3,000 a year ago to above the 3,600 level in early May, and currently trades at 3,446. Over the same period, the FTSE 100 index rose from 6,850 to above the 7,500 level

and now sits just below 7,400. There is no doubt that election results across Europe over the last twelve months have increased volatility with some big daily movements. However, if you stand back and look at these charts over a slightly longer term, both the Euro Stoxx 50 and the FTSE 100 show a nice smooth trend heading higher. That was until recently.

Increased volatility

Stock markets around the world hate uncertainty. In the run-up to the federal election in Germany there is likely to be increased volatility in the European markets ahead of the result. This level of heightened volatility could run for a while as the winning party negotiates with other parties to create a collation, as what is becoming clear is that neither the

CDU/CSU nor the SDP is likely to win a majority. It has to be pointed out that following the last federal election, the new German government was not sworn in for three months. That equates to three months of heightened uncertainty.

 The Euro Stoxx 50 and the FTSE 100 have hit attractive highs in recent months, but lately a move to safety seems to have begun. Indices of European stocks are moving sideways with lower tops which suggests that share prices might be on their way down. It is worth looking at the CBOE Volatility Index known by its ticket symbol VIX, which measures the implied volatility of the S&P 500 index options. The VIX, which is Wall Street’s so-called fear gauge, recently hit a record low level which historically seems to act as a precursor to a downturn. Perhaps the catalyst could be the forthcoming German elections.