With the Catalan crisis stalled, for now at least, all eyes have been on political risk in Italy and some arduous deal-making in Germany. After Sunday's result, Italy is likely to lurch into some frenzied horse-trading, but where will Merkel's new coalition of moderates get to? Lyxor ETF looks at the market for European equity
EMU risk assets have in fact held up pretty well to all of the political stress of recent months, but the economic recovery still seems underpriced. The equity market remains around 15% below the highs of previous cycles.
Euro Equity ETFs from 0.07% TER: find out more
Italian intrigue
Although the scaremongering did pick up prior to the election, the Five Star Movement was never going to get the majority it needed. A hung parliament was always the likeliest option - a slightly sullied status quo that won't help progress much-needed reforms or trigger any major disruptions.
The markets and the MIB might be mollified by a result which doesn't place the populists directly in power, but it won't change our view on Italian equities. They may well get left behind this year unless actions taken in the next few days lead to some form of constructive majority government. Parties in Italy aren't bound to their electoral allies post polling day, so some important decisions still lie ahead.
Should a centre right coalition be struck, we suspect we'll see more positive progress on reform and therefore expect to adopt a stronger stance on the outlook both for the MIB and EMU risk assets overall. On the other hand, should Five Star swallow its words and form a coalition with the eurosceptic, anti-immigration League party all bets are off.
A grand-ish coalition
September's election in Germany is a distant memory, yet negotiations to form a new government have taken five months - the longest in postwar German history. After renewing their seemingly fractured relationship, Angela Merkel's conservative CDU party and the initially unwilling Social Democrats (SDP) have finally combined to secure her fourth term in office. The courtship has been more difficult this time around - she has had to surrender control of the key finance, foreign and employment ministries to make the breakthrough. As a result, the direction the new government will take is hard to call.
The SDP was, essentially, strong-armed into ratifying the deal by voters. Had they not, they were faced with electoral extinction at the hands of the far-right AfD. A rigorous risk-off episode would have been inevitable. The will of the people, and the SDP's natural will to power, were enough to see them over the line.
We aren't certain the SDP's decision will do much to change what's a positive outlook for the DAX in the short term. Their "yes" favours domestic demand, German consumers and euro area banks.
Follow the money
Investors grew more wary of Europe in the latter part of last year given the three-pronged political risk. Appetite has however returned, especially in the US. Flows into eurozone equity ETFs are way ahead of where they were this time last year, despite the volatility of mid-February. Inflows have in fact exceeded those for US equities - potentially signalling the start of an asset allocation shift designed to exploit the valuation gap between the two markets.
Away from ETFs, long/short equity strategies and mutual funds have displayed similar results, with investors attracted by the alpha and beta potential of a two-speed Europe. The weekend's results may just have made that an even more concrete prospect - provided you are picky. "Macronomic" progress in France and probable debt forgiveness for Greece mean they remain our preferred eurozone markets, but Germany's outlook has just improved.
More: Use ETFs to invest in Greece
Pick your ground
Signs of such selectivity are already apparent. Country-specific ETFs have enjoyed a sharp rise in inflows, mostly towards Germany. The DAX, with its many exporters, seems to be more driven by swings in EUR/USD and global growth prospects than it is by political concerns. The single currency's weakness last month was clearly attractive. We expect more good news to follow, provided there's no great appreciation in the euro from here.
Lyxor's European equity range
With Lyxor, you can choose between six broad European or eurozone equity ETFs - among them some of the oldest and largest you can find. And, with TERs starting from just 0.07%, big picture thinking won't come cheaper. Of course, Europe is our home turf, so we've also built a range of single country ETFs built to exploit the best your market has to offer. Home in on household names with large-cap indices like the DAX, CAC or MIB, double up with our daily leveraged products or spot the next big thing with our mid-cap range.
Find out more about Lyxor's European Equity ETFs
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