We believe the local economic and market backdrop would be more influential in delivering investment performance in both Europe and Japan, and active selection in companies and sectors is important.
Global Market Strategist
Germany held its federal election on 26 September and the Liberal Democratic Party (LDP) of Japan will vote for its president this week, who will lead the party into a general election by November. One key question is the potential market impact of these elections for the third and fourth largest economies in the world.
The vote in Germany marks the end of Angela Merkel’s 16-year reign as chancellor. The center-left Social Democratic Party (SPD) have narrowly beaten Merkel’s Christian Democratic Union. For the first time in 60 years, Germany could have a three-party coalition instead of the usual two-party pact. However, forming a coalition could take months to complete with a range of possible outcomes and some tough horse-trading.
One clear trend is that German voters are leaning to the left. SPD advocates for greater wealth re-distribution and social transfers. It proposed raising the top income tax rate to 45%, and introducing a financial transaction tax and a wealth tax. The Green Party also saw a rise in support, and it wants to spend more on climate-related investments with higher taxes on high income earners. But no three-party coalition is possible without the free market center-right Free Democratic Party, which is promoting more investment in technology, tax cuts and less red tape, which is likely mitigating the shift towards bigger government, higher taxes and more regulations.
For Japan, the winner of the LDP presidential vote would assume the role of Prime Minister and lead the party into the next general election, which needs to be held by 28 November. The next LDP leader should enjoy some fresh momentum going into this vote and protect the party’s majority in the Lower House. Out of the four candidates, Taro Kono, minister in charge of the vaccination program and former foreign and defense minister, and Fumio Kishida, former foreign minister, are in prime position to win the leadership race. Sanae Takaichi, former internal affairs minister emerges as a dark horse candidate. These candidates are expected to announce their fiscal spending programs in the near future, even though they would have different opinions on fiscal consolidation in the long run. The Bank of Japan is expected to be allowed to run its monetary policy as needed.
EXHIBIT 1: GLOBAL AND ASIA EQUITY MARKET RETURNS
We believe the local economic and market backdrop would be more influential in delivering investment performance in both Europe and Japan, and active selection in companies and sectors is important. For Europe, the economic recovery has supported earnings improvement and the prospects of the European Central Bank maintaining supportive monetary policy should also help. In the near-term, supply-side bottlenecks could drag on the manufacturing sector, but impact on the services sector should be manageable.
For Japan, its equity market has underperformed the U.S. since the pandemic began. This underperformance has also led to less demanding valuations relative to the U.S. Yet, the improvement in the pandemic situation should allow the economy to reopen as we approach the Christmas season. The government is also expected to keep the foot on the fiscal stimulus gas pedal, especially around the time of the Lower House general elections. Most importantly, the global recovery should support the expansion of the global corporate capex cycle, which traditionally has a strong correlation with Japanese corporate earnings.
Since the start of the year, we have suggested investors be more globally diversified to better capture the benefits of the global recovery, as well as the staggered stages of rebound. While investors are more familiar with the U.S. and Asian markets, we believe there are opportunities in Europe and Japan. The latest political changes should not fundamentally change the investment case of these markets, since many companies operate globally and are leaders in their respective fields. The key would be to actively select sectors and companies. These companies, especially European ones, have placed more emphasis on addressing environmental, social and governance (ESG) factors. This could be a good component to build a more ESG-compliant portfolio.