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(Bloomberg) — A federal election is looming for a German equity market trading near all-time highs, and the impact is set to reverberate most across the country’s smaller stocks and sectors like defense and real estate.

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The country’s benchmark DAX Index has been partly buoyed by hopes that Conservative front-runner Friedrich Merz will team up with the Social Democratic Party and potentially the Greens to secure a robust voting majority in parliament. That’s seen as key to pushing through much-needed economic reforms and any potential loosening of strict borrowing rules, known as the so-called debt brake.

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If that happens, “we will have an equity market boom in Germany, especially in small and mid-caps, and it could stimulate a wider equity boom across Europe,” said Emmanuel Valavanis, equity sales specialist at Forte Securities Ltd.

In particular, the election result has implications for mid-cap stocks, which have lagged their large-cap peers. More exposed to domestic policy, mid-caps are seen to be winners if the election goes the way markets are hoping.

The mid-cap benchmark MDAX is near its cheapest against its large-cap counterpart since the global financial crisis, and the election could be a starting point for a rotation. 

The DAX index “needs earnings support from the election, such as business-friendly policies and higher fiscal spending, to continue to outperform its smaller peer MDAX,” said Bloomberg Intelligence strategists Laurent Douillet and Kaidi Meng, adding the MDAX “may be better positioned due to its higher exposure to the domestic and EU economy and the lowest valuation premium” since the crisis.

Still, the odds of a less market-friendly outcome — one with a potential blocking minority that would make fiscal reform extremely difficult — are at 55%, according to Goldman Sachs Group Inc. The convoluted process that might be needed to form a government — it took two months after the 2021 election — means investors could face a long period of wrangling and negotiation.

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“Investors expect lower corporate tax and stable electricity costs for industrial customers but should remember that structural changes take time, and the benefits will only be seen from 2026 onwards,” noted Franklin Templeton strategist Kim Catechis.

Here are the major stocks and sectors that could be most impacted by the election:

Defense

European defense stocks have made a spectacular start to 2025 and German spending support for the region’s rearmament is seen as continuing in most cases. What investors are now trying to figure is what different coalitions might mean for the exact numbers.

“Defense stocks are seen having continued spending support from most parties, except in the case that left-leaning parties Die Linke and BSW have more of a say,” Oddo BHF analyst Yan Derocles wrote in a note. He sees Airbus SE as one of the companies most exposed to the German budget, while Rheinmetall AG and Hensoldt AG are most exposed to policy on the war in Ukraine.

Before a rally this week, Citigroup Inc. analysts led by Charles Armitage, noted that an increase to 2.5% from 2% of GDP in spending would send defense companies’ valuations higher by 15-20%. Hensoldt, with its around 60% German exposure, would be most affected among companies they cover, followed by Renk Group AG.

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Real Estate

German real estate stocks are among those highly exposed to domestic policy, with rent freezes and housing supply high on agendas. The prospect of further rent control tightening, with a current freeze expiring at the end of this year, could become a crucial bargaining chip in coalition negotiations, according to analysts.

“With the simplification of town planning regulations and a plan to modernize infrastructure, property and construction companies could be the big winners,” said John Plassard, senior investment specialist at Mirabaud Group.

Should Merz come into power, Oddo BHF analysts see Vonovia SE, LEG Immobilien SE, TAG Immobilien AG and Grand City Properties SA benefiting, albeit modestly.

Energy & Utilities 

Since Russia’s invasion of Ukraine, energy costs have been a critical issue for businesses and households.

“It looks like lower energy costs are one of the few topics where a potential coalition could come to an agreement rather soon, as their positions seem relatively aligned,” said Deutsche Bank AG analyst James Brand, with nuclear an exception.

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“Greater policy clarity from the new government could significantly benefit E.ON, with smaller but notable impacts on RWE due to its limited German exposure,” said Tancrede Fulop, senior equity analyst at Morningstar. Still, a strong showing for the far-right Alternative for Germany party could create increased uncertainty, he added.

Autos, Chemicals & Industrials

The car industry accounts for about 5% of Germany’s GDP and nearly 7% of the DAX index. Larger centrist parties have expressed willingness to support it. This means efforts to revise the combustion engine ban or a reintroduction of any EV incentives could be particularly supportive for the downtrodden sector.

Still, while some might hope for a rally, the Stoxx 600 Automobiles and Parts index is already up almost 9% this year, slightly outperforming the broader market. 

Chemicals are also seen as an election winner. Having underperformed for several years, positive news concerning energy prices, fiscal support or deregulation in autos or real estate sectors could send shares higher.

Another positive for industrials would be higher infrastructure spending, though vastly dependent on the potential debt brake situation. Companies with the greatest exposure to Germany are Knorr-Bremse AG, Kion Group AG, Siemens AG and Siemens Energy AG, said Deutsche Bank analyst Gael de-Bray.

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DAX earnings would also get a boost from a potential corporate tax proposal put forward by CDU and CSU parties, said Morgan Stanley strategist Marina Zavolock, which would especially favor Porsche AG, BMW AG and MTU Aero Engines among industrials in their coverage. Deutsche Bank and Commerzbank AG would also benefit.

Tech, Banks, Insurance

Banks, insurance and tech giant SAP SE are among the companies that have led the export-heavy DAX’s outperformance as it defied Germany’s slowing growth, and are a potential haven if the election outcome is less market friendly. 

Otherwise, Mirabaud’s Plassard predicts further gains for big banks and insurers such as Allianz SE, which could see their valuations rise.

The election could be a positive for financials in the case of further efforts to strengthen capital markets and the European banking union, said Deutsche Bank’s Benjamin Goy. This could facilitate liquidity and capital flows across Europe and “ultimately unlock cross-border mergers between banks.”

—With assistance from Julien Ponthus and Blaise Robinson.

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