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One to Watch: Is the Dax set to shine?

What: The German election on 25th September is starting to grab investors’ attention now that it looks increasingly likely that Angela Merkel is set to win her fourth term as a coalition leader. The latest polls expect her party to win 37% of the public vote, with her nearest rival, the SPD led by Martin Shultz, winning 23% of the vote. The anti-EU/ anti-immigrant party the AfD is well behind with only a 9% share and with the major parties refusing to join a coalition with the AfD, it looks like the future of the Eurozone is safe.

The big unknown at this stage is who Merkel and her CDU party join forces with to form a coalition government, a common occurrence in Germany. She could join forces with the SPD to allow for a 2-party coalition, although the SPD may demand a greater say in power, which could make it a less attractive option for Merkel who may prefer to join forces with the smaller FDP and the Green party. Whichever combination of parties join forces with Merkel we think it could be enough to boost the Dax index as both coalitions are considered market friendly:

CDU and SPD: this could boost consumption as the SPD presses for Merkel to loosen the budgetary purse strings.

CDU/ FDP and Greens: the FDP are a centre-right business-friendly party that supports cutting corporate tax rates.

How: With the existential threat to the Eurozone likely removed with the outcome of the German election and a high chance of a market-friendly coalition, we believe that the best way to express this is through a relative value German/ Italian stock index trade.

As you can see in the chart below, the Italian FTSE MIB has outperformed its European peers including the Dax since Q2 this year. The outperformance really took off around July as Italian economic data has roared back to life, including a healthy Q2 GDP rate of 1.5%. Back at the start of the summer Italian shares looked like good value, however, after two months’ of strong outperformance their valuation is now starting to look rich.

In contrast, the German Dax index has had a mixed time of late. After peaking directly after the final round of the French election on May 8th, it struggled during the summer months as the export-heavy Dax was weighed down by the strength of the euro. Now that the euro has pulled back, the Dax has found its feet again, and we expect further gains as we lead up to the German election, and on the back of the a confirmed coalition led by the steady hand of Angela Merkel. Thus, we could see a shift in capital away from Italian shares and into the Dax in the coming weeks.

Chart 1: 

Source: City Index and Bloomberg 

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