Implications of the German Elections on Investment Portfolios

Merkel’s conservative alliance secured roughly a third of the German ballot during the September 24 election, with previous coalition partner SPD earning one-fifth of the vote. Combined, the two parties lost 105 seats in the Bundestag.

The biggest story of the election was Alternative for Germany (AfD), the far-right populist party that catapulted into third with roughly 13% of the vote. The anti-immigration, anti-EU platform won 94 seats, becoming the first overtly nationalist party to enter parliament in 60 years.

Chancellor Merkel has forged ahead with the so-called Jamaica coalition of conservatives, free marketeers and left-leaning environmentalists. The coalition, which is named after the parties’ combined colors, was the only realistic option Merkel had following the surge of AfD and the decline of the Social Democrats. From an ideological perspective, the biggest rift lies between Merkel’s Bavarian CSU party and the Greens, with the former reluctant to make too many concessions following its weakest-ever performance.

At the same time, Merkel needs to pay heed to the demands of AfD, given the party’s growing mandate. The Chancellor has vowed to win back AfD voters, something that will be difficult to do given her stance on immigration.

In addition to AfD, Merkel’s reliance on a multiparty coalition could hamper her government’s decision making going forward. Although Merkel is unlikely to deviate from her pan-European principles, the rise of nationalism will continue to threaten the survival of the European Union and the 19-member Eurozone.

Although Merkel’s victory was welcomed by stability-seeking investors, it has failed to quell Eurozone jitters ahead of a slew of elections in 2018. In other words, there’s still plenty of dissatisfaction to be found across the region. In the case of Germany, ignoring the real grievances of the populists is no longer possible or even politically viable.

That being said, the election result is unlikely to undermine Germany’s economic performance in the short term. In fact, a coalition government with the market-friendly Free Democrat Party (FDP) could be a boon for business. The party’s laissez-faire attitude toward fiscal policy has been reflected in its track record of supporting tax cuts and reducing state expenditure. That’s likely to continue moving forward, with the FDP already calling for a €30 million per year tax reduction.

All coalition partners are on the same page when it comes to lifting the burden for low- and middle-income earners. However, the FDP and the Greens could butt heads on the topic of environmental sustainability. The Greens want to see 100% of electricity generated by renewable energy by 2030. While the FDP isn’t opposed to renewable energy, it prefers a market-driven approach toward sustainability. It remains unclear how the Greens’ environmental platform will impact Germany’s massive manufacturing base, which is a key driver of the domestic and regional economies.

Germany accounts for roughly a third of Eurozone economic output and has been one of the main benefactors of a synchronized global recovery. However, that recovery has placed pressure on the European Central Bank (ECB) to begin normalizing monetary policy. That investors expect the ECB to act soon is partly reflected in the performance of the euro, which has soared to multi-year highs against the dollar.

Consideration for Investors

Against this backdrop, investors stand to benefit from mutual funds tied to the German and Eurozone economies. One of the best options is the DFA Continental Small Company Portfolio (DFCSX), which has returned a massive 31.5% year-to-date. The mutual fund has no minimum investment amount and holds $582 million in net assets. Roughly one-third of the entire portfolio is made up of Swiss and German stocks, giving investors plenty of exposure to Europe’s largest economy.

Investors seeking diversification in other European economies can also benefit from the Vanguard European Stock Index (VEUSX), which holds roughly 500 stocks with large exposure to British, French and Swiss companies. Annual expenses are a mere 0.10%, making VEUSX an affordable option.

In case you are wondering whether mutual funds are right for you at all, read about why mutual funds, in general, should be a part of your portfolio.

The fallout from the German election is still unfolding. For mutual fund investors, exposure to the regional recovery is likely to result in strong returns over the short and medium terms. Long-term, the performance of these assets will depend on the state of Eurozone integration and the impact of nationalism on regional cohesion. In this regard, the German election result is a clear signal that Europe is approaching another critical crossroads in its history.

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