It was a “landslide victory… for muddle”, says Conrad de Aenelle in the International Herald Tribune. Markets had been counting on a coalition of the conservatives and their pro-business liberal allies to accelerate economic reform after the German election.
What they got instead was a political stalemate – the conservatives finished only marginally ahead of the social democrats – with the prospect of weeks of wrangling before the eventual formation of a grand coalition of some kind. The uncertainty over the shape of the government and the possibility that reform will stall caused a wobble in the market, although the blue-chip Dax index has regained almost all the lost ground over the past few days and is close to its pre-election three-year high.
One reason for optimism is that, despite the current paralysis, both the main parties are committed to curing Germany’s economic problems, so further structural reform looks inevitable longer term, according to David Jane of M&G. But the market’s resilience may also be due to the realisation that, thanks to the Dax’s heavy exposure to cyclical industries, the state of the global economy matters more to the German market than does today’s political gridlock.
The key story remains corporate Germany, which hasn’t been waiting around for the government to effect change. Over the past few years, German firms have slashed costs, outsourced jobs and renegotiated working practices with the unions. The restructuring process is far from over, says Ronan Carr of Morgan Stanley. Indeed, electronics giant Siemens announced cost cuts worth €1.5bn as the market digested the election result.
Net income margins are still 3.5% below the European average, while German returns on equity of 9% are still a long way from the historical peak of 15%; European return on equity is close to its historical highs. Given a price-to-book-value ratio of just 1.8 – a 28% discount to the overall European market – and the third-cheapest European 2006 p/e of 13, German stocks should be re-rated as returns and margins catch up with the rest of the continent.
With the corporate cost-cutting, the “groundwork for a slow but steady economic recovery has been laid”, says Lex in the FT. There is scope for a virtuous growth cycle to develop once competitive companies increase business investment, which will lower unemployment and boost consumption. As Carr says, the election may not have delivered the “icing” of faster government-led reforms, but Germany remains “a tasty cake”