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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Kim Catechis

There is a feeling of cautious optimism in the United Kingdom ahead of the election in July, says Franklin Templeton Institute Investment Strategist Kim Catechis.

The Beatles’ George Harrison wrote “It’s All Too Much” after experimenting with the hallucinogenic drug LSD. The song was not a commercial success, says Catechis.

“But oddly enough, it captures the public mood in the United Kingdom after a torrid decade of Brexit, COVID-19, rising inflation, higher interest rates, and five prime ministers and seven chancellors in the last 14 years (with three prime ministers in the last four years).

“After 14 years in government, political parties tend to struggle in democracies, as they usually run out of ideas or are beset by internal divisions and cannot disassociate themselves from their track record. The polls ahead of the 2024 UK election have been remarkably stable over the last two years, showing the opposition Labour Party ahead of the Conservative and Unionist Party by a margin of around 20 percentage points. Prime Minister Rishi Sunak called a snap election for 4 July, catching most by surprise—and likely complicating the US ambassador’s plans for US Independence Day holiday celebrations that day!

“This election campaign is mercifully short (six weeks) but also unusual in its blandness. Both Sunak and the leader of the Labour Party are widely considered to lack charisma, which accentuates their lack of a strong agenda. The topics discussed at debates include immigration (too much of it) and public services including the National Health Service (not enough of them). The Conservatives have been talking about generational culture war issues, cutting taxes for pensioners and reintroducing national service for 18-year-olds, and appear to be trying to fend off the right-wing Reform Party with plans to deport undocumented immigrants to Rwanda. The Labour Party is being very vague on policy, probably to avoid alienating the centre-ground voters.

“There is an unresolved debate to be had over the philosophy of taxation, spending priorities and structural reforms. This could have been a unique opportunity to ask voters if they want the United Kingdom to be more like the United States, with low taxation and low social spending, or the European Union (EU), with higher taxation and strong social support services, including childcare, housing and education.

“Whoever wins, the starting point is suboptimal. The economy has been barely growing, productivity has been poor since 2008, and wages have barely increased in real terms in the last 14 years.^[1] Energy-driven inflation has been tough to deal with, and higher interest rates have added to the squeeze on consumers. Public finances are stretched, and the United Kingdom’s cost of borrowing is higher because of the misjudged budget^[2] of September 2022. Higher taxes or more borrowing will be needed to finance any investment to repair public services. Besides, there is an urgent need to reinvest in its defence capabilities, increasing the financing requirements further.

“The country seems trapped in a net of weak growth, weak productivity and relatively high inequality. Yet, both main parties are ignoring the obvious point—that all remedies will require financing via debt or increased taxes—or both. In the United Kingdom, the income tax levels range between 20 percent and 45 percent. The capital gains tax levels range between 10 percent and 28 percent. It seems likely that these might be harmonised, leading to a reduction in switching income to investment (in property for example) to minimise tax paid. Estimates suggest harmonisation could raise around £16 billion^[3] per year and given that only around 3%^[4] of UK adults pay this tax, it could be a politically astute move.

“There is a general market expectation that the UK economy will grow out of this predicament, but painfully slowly, unless productivity can be boosted. One of the obstacles is demographics. The workforce cannot be easily increased, because the rate of female participation in the workforce is already at 72%.^[5] In addition, the country appears to have 9.4 million^[6] economically inactive people who are between 16 and 64 years old, more than before the COVID-19 pandemic. Separately, the seasonally adjusted unemployment rate in the three months to April was up strongly, at 4.4%.^[7]

“The fiscal constraints and the productivity issues are not unique problems, and the capital markets appear to be positive about the prospect of a change of government, in the expectation that policy direction will be pro-growth, but with a cautious approach to fiscal policy. Supply-side reforms, stability of economic policy and potentially a concerted effort to smooth relations with the EU could help build confidence and facilitate trade flows. Investors appear to anticipate benefits for banks, homebuilders, and food retail, but a cloudier outlook for energy, where Labour leaders have indicated they want to extend or increase the Energy Profits Levy.

“The UK equity market is not especially cheap at a 12 month forward price-to-earnings ratio of 11.58 and its dividend yield of 3.7% is welcome, but not world-beating.^[8] Year-to-date performance suggests interest could be reviving and as inflation gradually eases, investors can likely look forward to a significant reduction in interest rates.

“The fixed income market recognises that the Labour Party must be keen to serve two terms, because the party’s project cannot be delivered in four years, so fiscal orthodoxy is virtually guaranteed. The recent uptick in unemployment and the gradual decline in inflation point to a peaking in interest rates. Further, with the low likelihood of a repeat episode of Liz Truss’ “Stranger Things.” bond investors may feel comfortable with 10 year Gilts at 4.33%.^[9]

“Sterling has enjoyed a measure of stability, gaining some ground against the euro year-to-date, as markets expect the Bank of England to cut interest rates more slowly than the European Central Bank. A “change of government, the perception of less friction in trade with the EU, and we believe the expectation of stability and orthodox policy direction could provide further support to British pound sterling this year.

“Finally, the city of London, which has been on a downturn since Brexit as jobs and transaction volumes have moved to the EU and some exciting tech companies have chosen New York for their listings, seems to be in a mood of cautious optimism. There are a handful of initial public offerings pending, after Raspberry Pi, (a British microcomputer maker valued up to £540 million), including Shein (a Singapore based Chinese fast fashion company) and DeBeers (the South African diamond giant), rumoured to be spun off by Anglo American as part of a restructuring plan.

“In a world where exchanges and economies evolve continuously, it does seem like there is a feeling of cautious optimism. It could be time to sing a later George Harrison song, “Here comes the Sun”!”

———–

Notes:
[1] Source: “Recent trends in public sector pay.” Institute for Fiscal Studies (IFS). 26 March 2024.
[2] Former Prime Minister Liz Truss and Chancellor Kwasi Kwarteng surprised with a “mini budget” based on increased borrowing and significant tax cuts; this resulted in a revolt by the capital markets, the Bank of England made the largest interest-rate increase in 27 years, and sterling hit an all-time low against the US dollar.
[3] Source: Arun Advani, Associate Professor (Economics), University of Warwick and Research Fellow, Institute for Fiscal Studies.
[4] Ibid.
[5] Source: “Women and the UK Economy.” House of Commons Library, Research Briefing. 4 March 2024.
[6] Source: Office for National Statistics (ONS), Economically inactive. As of April 2024.
[7] Source: Office for National Statistics (ONS), Unemployment rate, seasonally adjusted. As of April 2024.
[8] Source: MSCI, Macrobond, Analysis by Franklin Templeton Institute. As of 31 May 2024.
[9] Source: Macrobond as of May 31st, 2024

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Kim Catechis

Investors looking for opportunities in global markets need to pay attention to the post-COVID shift from globalisation to regionalisation, as countries take steps to secure their supply chains and protect their battered economies.

A recent megatrends investment forum hosted by Kim Catechis, investment strategist for the Franklin Templeton Investment Institute, turned its attention to the risk to the globalisation megatrend that has shaped global trade patterns for the past 50 years.

Alastair Reynolds, portfolio manager for Global Emerging Markets Strategies at Martin Currie and panellist at the event, noted: “Globalisation has proved a great boon for emerging market economies over much of the last 50 years, but looking forward, I expect that regional trade patterns will prove more influential than globalisation in determining the fortunes of emerging market companies.

“In the short term, this is likely to be most powerful amongst pan-Asian franchises, as I expect Asia to remain the most dynamic region on a global basis. It might also alter M&A preferences of companies away from seeking global expansion in favour of building regional dominance.

“So, near-neighbour acquisitions in Asia, Europe, Africa and the Americas may be a feature. Regionalisation could be motivated by serving regional preferences in financial services, infrastructure or consumer goods, or its motivations could be more political, such as in guaranteeing supplies of key commodities or inter-operability of technology and communications.

“A move from global ‘just-in-time’ supply chains towards more localised ‘just-in-case’ supply chains will necessitate a new wave of investment in fixed assets, which should be positive for capital goods companies, building materials and industrial real estate. There will also be a one-off step-up in demand as this new supply chain is stocked with inventory.

“However, the increase in activity required to create and stock a more localised supply chain will bring increased costs. Ultimately, someone must bear this cost, and this will present a new test to pricing power throughout industry supply chains.”

Sonal Desai, chief investment officer of Franklin Templeton Fixed Income and another panellist at the forum, added: “Rising protectionism, together with the pandemic, is driving changes in global supply chains and global trade. In the short term, these increase the risk of disruptions and related inflationary pressures.

“In the longer run, they will highlight the importance of well-developed local and regional supply chains, which could become a critical competitive advantage for countries and companies.”

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Kim Catechis

Four years into an escalating confrontation and nearly a year into the first truly global pandemic in a century, the world is poised for a geopolitical and economic rollercoaster ride, according to Martin Currie, a global investment manager.

Investors and asset owners are greatly impacted, so we need to track a variety of issues- historical context provides the motivation; economic heft provides the arguments; ideology appears to be driving policy and the result is a significant challenge for investors, writes Kim Catechis Head of Investment Strategy at Martin Currie in a new investment research paper.

He says: “The next decade will likely see increasing efforts to disassociate the two largest economies in the world. Investors are well aware of the mounting pressure on governments to take sides.

“In the developing countries, China’s offer of the BRI has already been accepted. The only issues that could potentially derail this development are a sudden and commensurate generosity of finance from the US, evidence of poor-quality execution in the BRI, or a particularly shocking political misstep by Beijing. All seem unlikely at this point, thus underlining that should the US-China decoupling continue, there are many countries already committed to the Chinese sphere of influence.

“The aggressive moves against specific companies by the Trump administration, however, have set dangerous precedents. It is not just a question of adverse publicity being driven by an unguarded tweet, it can impact the revenues and profitability of third-country companies, as has been demonstrated by the pressure campaign on Taiwanese TSMC in order to get at Chinese Huawei. In this case, TSMC enjoys a leading position in the industry, so the company has options that others would not.

“Investors need to stay abreast of developments and understand the perspective to identify companies that are particularly vulnerable. At the same time, investors should be planning for a future where an asset owner’s geography effectively determines the investment universe – something we have not considered for decades.”

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Kim Catechis

The advance of China’s digital economy over the last few years has been nothing short of incredible says Kim Catechis, Head of Emerging Markets at Martin Currie, the active equity specialist for Legg Mason.

The Chinese technology sector already makes up more than 30% of the country’s GDP and it is estimated this percentage will increase substantially over the next decade and more.

“This sector has political and economic momentum behind it, which is why the ‘Digital Silk Road’ – a vital, but often overlooked facet of China’s expansive One Belt One Road (OBOR) vision – will soon prove impossible to ignore,” notes Catechis.

“Investors should not ignore the Digital Silk Road, in favour of the more tangible OBOR road and sea link aspects. The innovation and developments at home and abroad, will establish China and its maturing technology companies as global leaders – setting the pace of change for others to follow,” he notes.

At the fourth World Internet Conference at the end of last year, Chen Zhaoxiong, vice-minister of China’s Ministry of Industry and Information Technology said the country’s aim was to ‘actively promote the digital silk road, to construct a community of common destiny in cyberspace’.

Within China, key pillars are being put in place to enable a world-leading digital infrastructure: The state has been substantially investing in areas of new technology, including a three-year plan to build an artificial intelligence (AI) application market valued at more than US$15 billion.^[1] There is also a major push to increase connectivity, including establishing 5G networks in the Pearl River and Yangtze River delta areas, and Beijing-Tianjin-Hebei region (in a minimum of five cities).

Catechis says “Arguably, China could soon lay claim to being the world’s most connected country.

“At the same time, China is looking outward, as are many of its businesses. This includes improving (or creating) IT infrastructure in developing nations along the OBOR route (the state-owned big three telcos China Telecom, China Unicom and China Mobile are laying cable links between Asia and Europe), establishing ‘smart cities’ along the OBOR route (with notable firms including ZTE and Huawei).

“At the same time, digital platforms and automation are helping ‘shrink the world’ – Alibaba has helped establish a digital free-trade zone in Malaysia, enhancing trade by speeding up the customs process.

“Enhancing this feeling of a technological shift from West to East, China has also established its own satellite navigation system BeiDou (Big Dipper), which it aims to expand to a global network of more than 30 satellites and compete with the US Global Positioning System,” he said.

[1] China’s Digital Economy – A Leading Force. Discussion Paper, August 2017, McKinsey Global Institute

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