Investors are expecting an eventual reduction of support by the Fed, and Merkel winning the election this weekend. However, what stock markets have not priced in is the resurgence of Eurozone troubles into the headlines. So what are the options, why is this important and how will this effect markets?
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3 Options, Same Market Risk
The least likely outcome is that Merkel does not get re-elected and instead the Social Democrats form a ruling coalition with the Greens. This would create a lot of uncertainty and shock the markets. However, the other two (main) options could also be cause for concern. Even if Merkel is re-elected and joins together with either the Liberals or the Social Democrats, the rising euro-skepticism and opposition to further bailouts severely limits her ability to support struggling Eurozone countries.
Resurgence of Economic Risk
The reason this is important is that troubles in the Eurozone are resurfacing. Skeptics have claimed Merkel has done a good job in keeping issues out of the headlines in the run up to the election, but either way there may be trouble ahead. Greece may need further funds, Portugal is struggling with borrowing rates hitting the dreaded 7% level and Slovenia may become the sixth country to request a bailout.
Beware Broad-Based Investing
So what does this mean for markets? In recent weeks we have seen European investments come back into favour. US investors have pumped capital into these markets at a rate not seen since 1977. Investors are, in particular, looking for high beta ways to either capture the market rally or in many cases catch up after being too cautious. However, these higher risk investments, based in the periphery European countries mentioned above, may come under particular pressure as funding needs are identified and struggle to be met.
Strong companies generating revenues outside of the troubled region will be more protected.