What's Next for Europe as Merkel Is Re-elected

What's Next for Europe as Merkel Is Re-elected

by David Zahn, CFA, FRM, Head of European Fixed Income, Franklin Templeton

Angela Merkel’s re-election as German Chancellor was very much expected, but the implications of her victory are harder to predict. Here three of our portfolio managers with a particular interest in Europe share their views on what Merkel’s victory could mean for the region.

Merkel is Likely to Have One Eye on her Domestic Audience

As expected, Angela Merkel was re-elected Chancellor of Germany. The big story for many commentators has been the level of support garnered by the far right Alternative for Germany (AfD) party.

For the first time in more than 50 years, a party of the extreme right has seats in the Bundestag.

Populism Isn’t Dead

In our view, that only goes to prove that despite the results of the French and Dutch elections earlier this year, populism in Europe isn’t dead. It’s just been taking a back seat.

We think it’s important not to overstate the situation: Realistically AfD is unlikely to have a significant influence over policy in Germany in the short-term. And, we would not expect any dramatic response from the bond market to these developments.

However, we think the level of support for AfD does reflect a protest vote from people who have been unhappy with the direction things have been going in Germany. That could have an influence on Merkel’s approach as she looks past her election victory.

Economy Remains the Focus

Mainstream politicians, including Merkel, will likely want to examine the reasons for this increasing support for extreme parties. And they’re likely to want to act to ensure the extremists don’t get an even larger vote next time round.

As we’ve noted before, populism tends to recede when the economy is doing better, but it can quickly re-emerge when discontent sets in. Therefore, we expect the economy to be a major focus of political attention.

People don’t tend to take to the streets when they have food on the table.

But, Merkel may also want to think about her approach to the greater integration of the European Union (EU).

In the past, Merkel seemed cautiously supportive of closer political and fiscal union across the EU.  She may now have to think more carefully about how those developments would play with her domestic audience.

On the other hand, given the pro-European credentials of France’s new president, Emmanuel Macron, Merkel is unlikely to do anything that could jeopardise her perceived role as de facto leader of Europe.

Reasons to be Optimistic over the Longer Term

by Dylan Ball, Executive Vice President, Templeton Global Equity Group

Angela Merkel’s victory in the German general election was probably not a surprise to most investors, but the support for extremist parties is likely to raise some eyebrows.

I think the market will be particularly concerned at the support for the populist Alternative for Germany (AfD) party, which secured seats in the Bundestag for the first time.

Some may see the AfD’s rise as a re-emergence of the sort of populism that we saw expressed in the UK Brexit vote and to a degree in the US presidential election.

Possible Higher Volatility in European Equities

Such populist concerns may lead to higher volatility in European equities. As a result, the market is likely to be more defensive and more cautious in terms of valuations. We’d expect the more defensive technology and consumer staples sectors to hold in fairly well, compared with financials or energy stocks.

However, we view this as just one election and think there are reasons to be optimistic from an investment standpoint.

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