Germany's Equity Markets Priced for Perfect Election Outcome, Raising Risk of Surprise

Surge in German Equities driven by Optimism on Post-Election Reforms

Europe's equity markets have scaled record highs this year, buoyed by expectations of a pro-business outcome in the upcoming German federal election. The DAX Index and Stoxx 600 have benefited from optimism surrounding potential fiscal stimulus and debt brake relaxation under a new government.

Historical Precedents Caution against Complacency

However, experts warn that betting on a clear election result on February 23rd may be shortsighted. In 2024, the European Parliament election unexpectedly toppled the French government and triggered a selloff in domestic assets.

Polls Signal Support for Increased Borrowing and Market-Friendly Reform

Opinion polls favor Friedrich Merz, the Christian Democrat candidate open to reforming the debt brake mechanism. A coalition between his CDU/CSU alliance and the Social Democrats or the Greens is seen as the most market-friendly outcome.

However, Anti-Immigrant Party's Strength Complicates Optimism

The anti-immigrant Alternative for Germany party's strong poll numbers could hinder inter-party collaboration and influence political decision-making. The potential for a protracted government formation process raises uncertainty for investors post-election.

Constitutional Change for Debt Brake Relaxation Requires Broad Support

While electing a government requires a simple majority, amending the constitution requires a two-thirds majority in both houses of parliament. Institutional investors anticipate an overhaul of borrowing limits, but a minority result could prevent fiscal expansion.

Signs of Overheating in German Equities

The DAX Index's surge has outpaced other European markets, driven by gains in tech and export-oriented stocks. Technical indicators suggest overbought conditions, raising concerns of a potential selloff.

Export Cushion May Insulate German Stocks

Some argue that German stocks are less exposed to election risks due to the large weighting of international and technology companies. However, others believe that even a Merz-led victory may not spark significant market rallies if fiscal reforms prove too timid.

Market Risks Similar to 2024 French Election

Analysts draw parallels between the current German election and the 2024 French election, where complacency led to a market selloff after a surprise outcome. The risk of a similar shock is present in the German equity market.