Ahmadreza Vafaeimehr Product Specialist, Germany IM Consulting contributed to this article.
On September 24, Germany heads to the polls to elect its next prime minister. This election takes place as the economy is showing signs of strength. The German economy is growing steadily, with the latest data showing 2.1% adjusted year-over-year real GDP growth in Q2, the highest reading in more than three years. Business sentiment is strong, with the IFO Business Climate index coming in at 115.9 in August, just below July’s all-time (post-unification) high of 116.0. Consumers are also buoyed by the record low 5.7% unemployment rate. Given these positive numbers, the Christian Democrats (CDU) and Chancellor Angela Merkel (who is now seeking a fourth term) are in a favorable position.
Germany’s exports have been performing well as Germany has emerged from the global financial crisis. More than half of the nation’s trade occurs with members of the European Economic and Monetary Union (58.9%), and its trading partnership with France (5.1%) has flourished, particularly in the wake of the Brexit referendum; however, trade with the ailing deficit countries (Greece, Portugal, Spain, and Italy) has not done as well.
The weak euro over the last decade has spurred exports to the UK and the U.S., resulting in increases in the bilateral trade surpluses with those countries; more recently, Brexit and a weakening dollar have reduced those surpluses.
These pre-election days are evocative of the 1950s, when, having overcome wartime destruction, (West) Germany’s growing prosperity and wealth was labeled as an “economic miracle” led by CDU Chancellor Konrad Adenauer and his economy minister (and successor) Ludwig Erhard. German voters historically seem to trust the CDU party to steward the economy better than the Social Democratic Party (SPD) and other smaller parties. However, it was the so-called Agenda 2010 along with its liberal but still controversial labor market reforms (introduced by the SPD and Chancellor Gerhard Schröder in the early 2000s) that likely laid the foundation of Germany’s economic robustness.
Despite an overall strong economic situation, voters tend to cast their votes in unpredictable ways, leaving some scope for surprises a few days ahead of the election. Back in January, with Martin Schulz standing up as the candidate for the German Chancellorship, polls showed the CDU and SPD almost tied (34% vs. 33% - IfD Allensbach, March 2017) or the SPD marginally beating the CDU (32% vs. 31% - Insa Consulere, March 2017). Looking at the most recent poll results, however, there is a 10-15 percentage-point difference on average between the two parties, with the CDU leading. Statistically speaking, sharp and disruptive policy changes are unlikely. However, given Germany’s role as the largest national economy in Europe, its overall political importance, and the need to build functioning coalitions between parties, the election inherits a touch of unpredictability and political uncertainty, especially for the financial investment community.
A Closer Look at Volatility Surrounding National Elections
In light of the pending German election, let’s take a broader look at how national elections can effect stock returns and volatility for both domestic and international investors.
There is published research on the impacts of national elections on stock market volatility. For example, a paper by Bia?kowski, Gottschalk, and Wisniewski, published in the Journal of Banking & Finance in 2008, found that country-specific components of index return variance can easily double during the week around an election. The article concluded that investors are generally surprised by the election outcome.
Testing Political Volatility
Let’s examine excess return and relative volatilities around election dates. The analysis focuses on national elections in 19 countries during the periods presented below. In total, our sample contains 91 elections.
Elections Covered:
| Index | Start Date | End Date |
| Australia | 2004-01-02 | 2016-07-02 |
| Belgium | 2002-01-02 | 2014-05-25 |
| Brazil | 2006-05-25 | 2014-10-05 |
| Canada | 2006-03-02 | 2015-10-19 |
| Finland | 2002-01-02 | 2015-04-19 |
| France | 2003-04-14 | 2017-05-07 |
| Germany | 2002-01-02 | 2013-09-22 |
| Italy | 2006-10-11 | 2013-02-24 |
| Japan | 2004-05-06 | 2016-07-10 |
| Korea | 2004-05-03 | 2017-05-09 |
| Netherlands | 2002-01-02 | 2017-03-15 |
| Singapore | 2009-11-18 | 2015-09-11 |
| Spain | 2007-05-14 | 2016-06-26 |
| Sweden | 2007-01-26 | 2014-09-14 |
| Switzerland | 2002-01-02 | 2015-10-18 |
| Taiwan | 2004-01-02 | 2016-01-16 |
| United Kingdom | 2002-01-02 | 2017-06-08 |
| United States | 1990-01-01 | 2016-11-08 |
MSCI country indices were used here to study the domestic stock market reactions to elections. As the sample contains several elections for each country, the average returns and the median volatility across all elections were used. This analysis focuses on price developments for 30-days pre- and post-election.
As the table below shows, there was an increase in absolute monthly returns from -0.73% to 0.13% after elections across the entire sample. However, we know that absolute returns were impacted not only by elections but also by general stock market conditions. This is especially important as the sample contains elections that took place during the 2008 financial crisis. To eliminate the general market impact, testing the MSCI country indices vs. the MSCI AC World index can give us a view into excess return. The results show a decrease in the monthly excess return from -0.28% to -0.91% indicating general underperformance of domestic market around elections.
Change in relative volatilities can be defined as the ratio of the respective market’s volatility to benchmark volatility. We can calculate the percentage change in relative volatilities and report the median statistics for elections of each country. As this table shows, relative volatility increased by 5.76% post-election for the whole sample.
Here are one-month return and volatility details pre- and post-elections. We used MSCI country indices to examine market movements, and the benchmark is MSCI AC world countries.
| Avg. Pre Election Return | Avg. Post Election Return | Avg. Pre Election Excess Return | Avg. Post election Excess Return | Median relative Volatility ChANGE |
|
| Belgium | 3.72% | 2.04% | 1.73% | 0.34% | -18.68% |
| Spain | -6.54% | 2.34% | -5.00% | -0.83% | -16.36% |
| Italy | -5.19% | -1.93% | -3.13% | -5.51% | -11.65% |
| Germany | -1.60% | 0.57% | -1.35% | -0.54% | -5.88% |
| Sweden | 1.73% | -0.88% | -1.32% | 0.24% | -4.13% |
| United States | 0.72% | -2.60% | 0.20% | -0.17% | 1.84% |
| Brazil | -2.37% | 0.54% | -3.70% | -3.49% | 2.07% |
| Australia | 0.51% | 4.76% | 1.50% | 3.40% | 2.15% |
| France | 0.76% | 0.86% | -0.09% | -0.41% | 3.49% |
| Switzerland | 0.86% | 0.73% | -0.66% | -1.45% | 5.99% |
| Finland | 3.87% | 4.64% | 1.63% | 1.82% | 7.44% |
| Singapore | -8.35% | 1.48% | -0.81% | -1.06% | 12.11% |
| Netherlands | -0.93% | -3.47% | 0.25% | 0.73% | 14.04% |
| Korea | 0.91% | -4.70% | 1.95% | -4.25% | 17.70% |
| Canada | -7.46% | -6.41% | -3.83% | -4.02% | 19.69% |
| United Kingdom | -0.25% | 1.45% | 0.04% | -0.76% | 20.37% |
| Taiwan | 1.98% | 4.74% | 4.85% | 1.01% | 20.45% |
| Japan | 4.19% | -1.75% | 2.61% | -1.45% | 20.91% |
| Total | -0.75% | 0.13% | -0.28% | -0.91% | 5.76% |
To test the odds of extreme returns around election dates, we examine the histogram of the excess returns. As Figure 1 shows, the results indicate a moderate skewness for pre-election excess returns and no significant skewness post-election, indicating that post-election distribution is almost symmetric. In addition, the distribution of post-election excess return is more platykurtic, meaning that the results are less concentrated around the mean than a normal distribution. Cumulative probabilities indicate that the chance of larger than -4% excess returns prior to election date is 14% and it increases to 25% post-election. Similarly, the probability of getting returns lower than -2% increases from 26% to 38%.
Despite the current strength and stability of the Germany economy and polling indicating a comfortable margin of victory for the ruling CDU, there is still an element of uncertainty heading into this weekend’s national election. An analysis of historical returns indicates that, in general, markets experience negative excess returns and increased volatility post elections. Most signs point to a predictable result in the upcoming German election, but there is always some element of uncertainty, particularly in the wake of recent election surprises.
Article by Christian Fleischmann, FactSet
