Europe's growth opportunities post German election

Cape Town - As expected, Angela Merkel has emerged as the victor in the German elections with her centre-right CDU/CSU bloc winning 33% of Sunday’s vote.

The centre-left SPD took 20.5% and has said it will go into opposition. The dominant parties in Germany remain pro-EU although the far-right AfD won a higher-than-expected 12.6% of the vote.  This is according to Rory Bateman, head of UK and European equities at global asset manager, Schroders.
 
Bateman says negotiations over the formation of a governing coalition will now take place and these may take some time.
 
“While Merkel is set to remain as Chancellor, her CDU/CSU bloc won a smaller share of the vote than expected. Nonetheless, Merkel played the election campaign well, having regained the impression of offering calm and controlled leadership. Internationally she continues to be seen as a 'safe pair of hands',” says Bateman.
 
Strong euro a risk for Germany

Of concern for Germany is the recent strength of the euro, given the country’s export-led economy.

According to Bateman, the election result has seen a slight dip in the euro, but this may prove short-lived.

"In the longer-term, the European Central Bank (ECB) will be keen not to taper quantitative easing too quickly so as to avoid further upward pressure on the currency. Meanwhile, ECB president Mario Draghi is talking down the risks of inflation in 2018.”
 
Is further EU integration likely?

With elections over in both France and Germany, it had been hoped that a stronger alliance between the two could provide a boost to EU cohesion after the UK’s damaging decision to leave.

For example, Bateman explains, there could be further strides towards a full banking union or a eurozone deposit protection scheme. On the fiscal side, Merkel has already proposed a “eurozone fiscal facility” which provides preferential loans and guarantees for those countries willing to adopt reformist agendas.
 
“However, achieving deep European reforms looks likely to be a complex process given the uncertainty over the formation of a governing coalition in Germany,” says Bateman.
 
Europe’s economy is recovering

After Emmanuel Macron’s victory in the French elections earlier this year, Bateman says there continues to be hope that he can enact much-needed structural reforms.

“These include improving labour market flexibility, decreasing union power and reducing employment overheads. A more dynamic French economy would, of course, be beneficial for Germany and the wider EU,” he explains.
 
“Overall though, the European economy is recovering nicely. We see scope for further gains for European equities, driven by ongoing low-interest rates and improving corporate profit margins. In fact, we believe investors could potentially see a market appreciation of up to 30% from current levels on a three-year view.”
 
Lower rates imply higher stock market valuations

Although the European economy is performing well, and other major economies are doing likewise, this is not translating into higher inflation. As a result, there is little pressure on the ECB or other major central banks to raise interest rates.
 
Bateman says: “In our view, this means interest rates should normalise at a lower level than we have seen in the past. History tells us that as interest rates decline, the valuation placed on the market increases. Therefore, if interest rates normalise at a lower level than has previously been the case, then this implies that the market valuation should be correspondingly higher.”
 
Profit margins playing catch-up

According to Bateman, since the global financial crisis, corporate profit margins in Europe have lagged behind those of the US.

"The eurozone crisis of 2011-12 seriously impacted corporate profitability. It has taken a substantial amount of time for capacity utilisation in the economy to improve and for unemployment to come down,” he says.
 
“However, European corporate profit margins are now improving. We think this is the start of a multi-year process where European profit margins will eventually return to levels similar to their US counterparts. This would be consistent with the experience of the 2000s and could be another driver of stock market gains.”

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