After Merkel: the prospects for Germany, the EU and monetary policy

05 October 2021

Angela Merkel has been Germany’s Chancellor since 2005 but is set to retire as soon as a successor emerges from the results of the 26 September election. German GDP per capita has increased almost 18.5% over that time, despite the pandemic. Unexpectedly, the election campaign had little to do with Mrs Merkel’s record and politics, focusing instead on the environment and social questions such as the minimum wage, the taxation of firms and the wealthy and the welfare system. In that respect it echoed many of the themes aired in the US presidential election a year ago.

Europe’s politics are now all about budgetary stimulus. On 15 September, Ursula von der Leyen declared in her State of the Union address to the European Parliament that the EU would not repeat its mistake after the 2008 crisis of tightening fiscal policy too quickly. This suggests that EU budgets will remain expansionary for some time yet. The ‘Frugal Four’ – the Netherlands, Austria, Denmark and Sweden – have said that they are open-minded, although remain profoundly attached to sound finances. Will they and other member States keen on tight fiscal policies now lose an ally in Germany? Not really. We believe that Germany will support recovery via the EU stimulus package but would not want free lunches to persist into the long term.

Interestingly, of all the candidates for Mrs Merkel’s job, front-runner Olaf Scholz is closest to her politics, albeit minus a shot of liberalism. It seems likely that Germany will continue with its balancing act, having a degree of sympathy for the ‘Frugals’ and an unappreciative eye for the financial position of southern eurozone countries. The challenge for Mr Scholz would be to reconcile German rigour with a more sustainable social model. If he becomes Chancellor and meets that challenge, Germany should retain its economic status as well as its leadership in European institutions.

Following the best second quarter for US companies since the end of the subprime crisis, with S&P 500 firms reporting a 90.9% jump in earnings growth, the coming quarters will normalise amid fading Covid-related base effects. The FactSet consensus estimate for Q3 is a 27.6% gain, which would be the third-largest since 2010. Sector performances are expected to mirror those in Q2, meaning particularly striking earnings recoveries among companies that suffered the most in 2020. The energy sector will be top of the heap, especially as it continues to benefit from surging oil prices (WTI and Brent crude prices are now and per barrel, respectively). In the near term, the catch for many US firms is inflation. In the light of recent CPI data, almost half of S&P companies used the word in their Q2 results announcements. This was the highest proportion noted since 2010.

Both American and European equity indices corrected in September. Bond yields rose upon Fed chairman Jerome Powell’s observation that quantitative easing would start tapering off reasonably soon (probably before year-end). In the Federal Open Market Committee put it, “If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted”. Against this backdrop, our valuation model indicates that a further consolidation in US share prices is required. In the euro zone, 30-year yields have followed the same trajectory as their US equivalent. Here too, we expect 2021 to be as good for corporate results as it will be in America, and our model suggests that European equities are currently at fair value or even slightly underpriced, and irrespective of the economic scenario.

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