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German election shows political risk hasn’t abated in Europe

Angela Merkel

A stronger-than-expected result for a right-wing party in the German general election is keeping political risk in European markets, money management executives warned.

Results of Sunday's election saw Angela Merkel succeed for a fourth term as chancellor with her party, the CDU, taking the largest share of votes. While that outcome was expected, right-wing party Alternative for Germany gained 13.5% of the vote, which managers said was not anticipated.

"This is a fairly hollow victory for (Ms.) Merkel, who will have to negotiate a more complex coalition agreement against the backdrop of the AfD breaking through into the mainstream," said Lucy O'Carroll, chief economist at Aberdeen Standard Investments. "Anyone who might have thought that European political risk had disappeared will have had a rude awakening."

Timothy Graf, head of macro strategy Europe, Middle East and Africa at State Street Global Markets said in a comment Sunday: "In forcing German Chancellor Angela Merkel to cobble together a coalition with at least two other parties, the potential for headline risk is at its highest. While the actual market impact is likely to be minimal over the medium term, this weekend's result does introduce more risk into European political proceedings than previously estimated."

Dylan Ball, executive vice president at Templeton global equity group at Franklin Templeton (BEN) Investments (BEN), said some might see the AfD's rise as a re-emergence of populism. "Such populist concerns may lead to higher volatility in European equities. As a result, the market is likely to be more defensive and more cautious in terms of valuations. We'd expect the more defensive technology and consumer staples sectors to hold in fairly well, compared with financials or energy stocks."

However, Mr. Ball added Templeton executives "view this as just one election and think there are reasons to be optimistic from an investment standpoint.

Executives also commented on the impact on institutional reform within the eurozone. Ms. O'Carroll said the result "raises questions over the eurozone's ability to engineer substantial institutional reform through a concerted Macron-Merkel push, as she is likely to be preoccupied fighting domestic challenges. It may not mean much for the U.K.'s Brexit negotiations in the short term, as these are being led by Michel Barnier rather than the individual EU member states. In the longer term, however, it could well increase the EU's reluctance to make many concessions for fear of putting more wind in the populists' sails."