The market was deeply worried about the possibility of the latter outcome as investors believed that the German economy would be paralysed by indecision and that a large coalition would be less likely to push through the economic and social changes Germany so desperately needs to return to sustainable growth.
We believe the worries are over done. The SPD government under Gerhard Schroder started the ball rolling in terms of reforms over the past seven years. It could be that the CDU and the SPD are singing from the same hymn sheet.
The ground work of a slow, but hopefully steady, economic revival in Germany has been laid. Industry has restructured aggressively over the past decade, partly by outsourcing jobs and selling non-core activities. This has restored finances and profits are healthy again. But while unit labour costs have been cut domestically, on some measures they are now back to the levels of the early 1990s, they are still one of the highest in the world.
The next phase must be to encourage domestic investment which will reduce the near-record unemployment of 4.7m or 11.4 per cent of the workforce and spur consumer spending, triggering a virtuous cycle. There are signs that Germans are starting to rediscover their confidence – which has led to the improvement from the German stock market.
The uncertainty will weigh on the stock market. It is therefore crucial that the political position be clarified swiftly. Ms Merkel must commit rapidly to further bold reform, and tackle the pensions, social security and health systems imbalances, or risk seeing Germany sink back into gridlock.
Despite the uncertainty of European politics, European equities will continue to improve profitability. One of the driving forces behind European companies’ ability to expand margins in recent years has been M&A. Since monetary union M&A activity in Europe has been directed primarily towards industry consolidation and not empire building. With margins at record levels many doubt their sustainability, yet they remain below those in the US and with M&A likely to continue, investors might be surprised by the sustainability of higher margins.
Diane Jones, senior portfolio manager, European equities, Northern Trust Global Investments.
