An Investor’s Guide to the German Election Results

German chancellor Angela Merkel’s conservative Christian Democratic Union (CDU) and its Bavarian sister party, the Christian Social Union (CSU), romped to victory in German parliamentary elections on Sunday, claiming 41.5% of the vote.

That put them well ahead of the second-place center-left Social Democratic Party (SPD), with 25.7%. The Left Party, which evolved from the old East German communist party, took 8.6%, followed by the Greens with 8.4%.

Merkel’s Steady Hand Wins Over Voters

The victory, which ushers in Merkel’s third term, is a strong endorsement of her steady leadership during the Eurozone debt crisis.

“I think it’s a validation of her leadership and her leadership style. I think the German people said, ‘We have gone through an extraordinarily turbulent period, and we like what we’ve got,’” former U.S. ambassador to Germany Philip Murphy told Deutsche Welle.

Germany uses a mixed-member proportional system that places a minimum requirement on parties to claim seats in the lower house, or Bundestag, and also makes it difficult for one party to form a majority on its own. That feat has only been accomplished once, under Chancellor Konrad Adenauer in 1957. Merkel came close, however, falling just four seats short.

That means Germany’s government will still change at least somewhat, because the CDU’s preferred coalition partner, the pro-business Free Democratic Party (FDP), failed to reach the 5% threshold needed to enter the Bundestag. That will force Merkel to seek an alliance with one of two parties that share less common ground with the CDU: the Social Democrats or the Greens.

Delicate Negotiations Ahead

A tie-up with the SPD, known as a “grand coalition,” will mirror the arrangement during Merkel’s first term, from 2005 to 2009, which included the global financial crisis.

The key questions for investors are how long it will take for negotiations to produce a government and what will Merkel have to give up to satisfy the SPD. Potential givebacks could include a tax on high-income earners and a national minimum wage, both of which Merkel has opposed and could slow growth.

The talks could also take some time: The last grand coalition government, in 2005, took over eight weeks to hammer out. In addition, the SPD lost ground in the 2009 election, after the last grand coalition, so it may be reluctant to enter into another agreement with Merkel. However, her decisive victory in Sunday’s vote will give her a strong hand to play in the discussions.

“The outcome leaves markets somewhat in limbo, despite positive headlines helping the euro (and hurting the dollar), and supporting both risk assets and peripheral European bonds,” wrote Societe Generale analyst Kit Juckes in a research note quoted by CNBC.

Germany’s Economy Is Performing Well

Germany accounts for 28% of the entire European economy, and the election result comes in the wake of stronger economic data from the country. In the second quarter, Germany’s GDP rose 0.7%, to an annualized rate of 2.9%, making it the fastest growing of the world’s industrialized economies. U.S. GDP, by comparison, expanded at an annualized rate of 1.7%.

The DAX 30 index has also gained ground this year, rising nearly 14% since the beginning of 2013 and hitting an all-time high on Thursday, just three days before the vote. However, that likely had more to do with a global stock market rally in response to the Federal Reserve’s decision to continue its bond-buying program at the current rate.

German investor confidence is also at three-year highs, with the ZEW Center for European Economic Research’s index coming in at 49.6 in September, up from 42 in August and ahead of the reading of 45 that economists expected.

High Energy Prices, Shrinking Population Could Hinder Growth

Even so, the country faces some challenges. One is electricity prices, which are rising sharply as Germany shifts away from coal and nuclear and toward renewable power.

The move is part of Merkel’s $735-billion plan to shutter all of Germany’s nuclear plants by 2022. By 2050, Germany aims to get 80% of its power from renewable sources. Consumers now pay more for electricity than users anywhere else in the European Union except Cyprus and Denmark, according to EU data quoted by Bloomberg.

Nonetheless, as Investing Daily managing director John Persinos wrote in an article yesterday, Merkel’s re-election likely cements the plan in place. He sees Canadian Solar (NasdaqGS: CSIQ) as a good way for investors to profit from it, as the company already enjoys steady demand for its components and systems from German solar power plants.

Another issue the government must grapple with is the country’s shrinking population. According to an August 13 New York Times article, the latest census indicated that the population was about 1.9%—or 1.5 million people—smaller than expected, and by 2060 the country could lose another 19% of its people, bringing the total to around 66 million, down from 80.2 million in 2011.

Flicker of Life on the Continent?

Thanks to Germany’s strong growth, the euro zone’s GDP expanded 0.3% in the second quarter, to an annualized rate of 1.1%. That ended six straight quarters of economic contraction, pulling the region out of the longest recession since World War II. France, too, saw better-than-expected growth in the quarter, with GDP gaining 0.5%.

Europe’s economy remains fragile, but these figures fit with other indicators that it may be stabilizing. For example, as we wrote in an August 6 Investing Daily article, Ford (NYSE: F) recently reported sales gains in Europe and said economic conditions there “may have begun to stabilize.”

Goodyear Tire & Rubber Co.
(NYSE: NasdaqGS: GT) also reported higher sales volumes on the continent in its latest quarter, and as we wrote on September 12, McDonald’s (NYSE: MCD) owes most of its better-than-expected same-store sales gains in August to a stronger performance on the continent, especially in France.

No matter what happens with the coalition talks, most analysts see a continuation of Merkel’s incremental, austerity-based approach to the continent.

“Germans are afraid of the side effects of the eurocrisis, and they believe that Ms. Merkel was able to protect German money against the demands of foreigners,” Gero Neugebauer, a political scientist at Berlin’s Free University, told the Christian Science Monitor. “[Germans] believe we should help [ailing economies], but they have to contribute to their own fates first.”

An Easy Way to Invest in Germany

Investors looking to tap into potential German gains could do so through the iShares MSCI Germany ETF (NYSE: EWG), the largest and most popular Germany-focused exchange traded fund.

The ETF aims to track the MSCI Germany Index, which seeks to measure the price and yield performance of publicly traded stocks in the German market, before fees and expenses. It is well diversified, with 20.33% of its holdings in the consumer discretionary sector, followed by financials (16.91%), industrials (14.52%), materials (14.47%), health care (13.09%) and information technology (7.58%). Other sectors make up the remaining 13.1%.

Major holdings include Bayer, Siemens, BASF, Daimler, SAP and Deutsche Telekom. The fund’s expense ratio is 0.50%, and the units are up nearly 13% since the start of 2013.