Kim Catechis

Kim Catechis, Investment Strategist, Franklin Templeton Institute calls the German election as “the most meaningful election of 2025.”

He adds “Policy proposals during the campaign included some level of debt brake reform, although probably not to the degree that capital markets would like. Markets will also be looking for the establishment of a special purpose fund (or funds), which could be quickly launched to allow greater expenditure on defense, infrastructure and energy.

“Investors are expecting lower corporate tax and stable electricity costs for industrial customers, although should remember that structural changes take time, and the benefits will only be seen from 2026.

“Equity investors are focused on the CDU/CSU proposals to reduce the corporate tax rate from 30.8% to 25% over four years. Analysts estimate this could boost earnings for equities by 1.1% in 2027 and up to 1.9% in 2029. The sectors that would likely benefit most are defense, utilities, capital goods, autos, property and, to a lesser extent, banks and chemicals.

“German elections have not historically driven movements in the Euro, regardless of outcome. The focus in currency markets is almost exclusively on the potential reform of the debt brake, which would require a two-thirds majority in the Bundestag. However, if the other reforms such as taxes, finance for defense and energy security) come through, this should underpin the Euro.”

Anna Rosenberg, head of geopolitics at the Amundi Investment Institute, noted “forming coalition will be easiest of next German Chancellor’s many challenges.”

“The centre-right Christian Democratic Union/Christian Social Union won the German elections held on February 23 with 28.6% of the votes, putting CDU leader Friedrich Merz on track to be the next Chancellor. His first job will be to form a coalition government. Negotiations with the Social Democrats, which came third with 16.4% of the vote, will focus on bridging differences on issues such as fiscal reform and domestic policies.

“A change in the fiscal stance is likely, with more spending on defence, but may not result in a major stimulus.

“Uncertainty over tariffs has been weighing on confidence and domestic demand since the start of the year. As a result, the economic outlook for 2025 is bleak. The government has recently cut its growth forecast for this year to 0.3% (compared with the 1.1% it expected as recently as October). And the Federation of German Industries (BDI) is even more pessimistic, forecasting a further contraction in GDP this year of around 0.1%.

“The next government will therefore have to tackle the economic concerns that largely dominated the election campaign. Some of the reforms proposed by the CDU to boost growth have no budgetary cost (e.g. cutting red tape). However, the parties that will form the next coalition recognise that additional fiscal resources will be needed.

“We expect the next coalition government will mobilise fiscal policy more proactively and that this will contribute significantly to German growth next year. However, the coalition contract negotiations will need to be monitored very closely in the coming weeks to confirm this view.”

The investment implications according to Rosenberg

Fixed Income: The two main reasons to be cautious about German debt in global fixed-income portfolios before the elections are still firmly in place. First, German government bond yields are the lowest in the euro zone and among the lowest in Europe, so more attractive valuations are on offer elsewhere. Second, Europe’s largest economy has been underperforming its peers and needs a significant fiscal boost, particularly on investment.

That will mean issuing more debt at a time when global government bond supply is already very high relative to history and central bank balance sheets are shrinking rather than growing. Given this backdrop, German yields would need to rise further if they are to become more attractive, and especially so for long-maturity bonds. While this could lead to a further steepening of the German yield curve, there is a need to remain agile on positioning at the short end.

This part of the curve will be sensitive to any inflation numbers that might challenge market expectations that the European Central Bank will cut policy interest rates by a total of 75 basis points this year. Only a sustained bout of risk aversion would prompt a re-evaluation of the appeal of German Bunds given their traditional role as a safe haven but, for the moment, there are better risk/reward opportunities on offer.

Investors may, for example, find value in carry trades that offer good visibility. Potential candidates include Italian, Spanish, and Greek bonds, and possibly Polish or Hungarian debt.

Equities: Germany’s blue-chip DAX index has had a good run over the past 12 months, outperforming other major European bourses, and even the S&P500, by delivering total returns of around 30%.

The rally came despite well-documented domestic economic challenges and was driven by stock-specific issues, the sectoral exposure within the index (40% of the index is accounted for by just four stocks), and the significant global revenue exposure of index members (80% of DAX members’ sales are generated outside Germany).

Despite this strong performance, the index remains reasonably valued, relative to both its own history and other markets, at 13.7 times forward earnings. Moreover, consensus estimates anticipate EPS growth of 11% for the DAX over the next 12 months, above the 8% expected for the broader European market, and not too far from the 13% predicted for the US market.

Valuations do not seem unduly optimistic and investors’ focus will now turn to the chances of a reform of the debt brake and the new government’s appetite to set up a special fund focused on defence, and possibly infrastructure. Its ability to deliver corporate tax cuts and ease the regulatory burden on companies will also be of interest.

Such an outcome would benefit domestically focussed companies (small and mid-cap stocks enjoy higher domestic exposure), more cyclical companies, and in particular those exposed to a potential boost to infrastructure and defence spending.

More broadly, coalition negotiations that suggest key reforms may be delivered would be positive for the wider European economy and regional equity markets.

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