Sheltering portfolios around the French election

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Chris Darbyshire, Chief Investment Officer.
10 April 2017.

In three months’ time, the French will have queued up four times in two (separate) elections. Their first selections take place in April and May as they plump for their new president. François Hollande (reasonably) decided not to stand again given his approval rating at the time stood at just 4%.

A month later and the population will be polled for their choice of legislative representatives to sit in the National Assembly.

Now there are just under two weeks to go to the first vote on 23 April that whittles down the current list of 11 presidential candidates to two. The second round on 7 May then selects between those two initial ‘winners’.

If the current polls are to be believed that second bout would see Marine Le Pen of Front National (a party on record denying that the Holocaust took place) go head-to-head with Emmanuel Macron of En Marche (a brand new political party still recruiting its candidates from the left and right of political views). The only mainstream player with a chance of getting a shoo-in for the second round is François Fillon. Initially tipped for an easy victory, he though now languishes in third following a succession of allegations from fake jobs for his family to luxury gifts of €50,000 suits.

If the situation were not strange enough, it is becoming yet more distorted given 37% of the voting population are expected to just stay at home on that first Sunday. That’s almost double the usual 20% of non-voters and so increases the chances of a shock result – especially for the European Commission – although perhaps less of a surprise than if we were to wind back the clock to this time last year.

The Commission’s concerns centre on a Le Pen victory – unease that is all the more compounded by the ardency of her supporters. They are far more likely to actually get out and vote than those of Macron (85% versus 65%). Meanwhile, the CIA is the latest intelligence agency to voice fears over Russian interference in French politics. The influence, rumoured to have helped Trump triumph in the US, also apparently surfaced more recently in Montenegro and the Netherlands, leading the Dutch to turn back to using paper ballots to avoid election fraud.

For the bureaucrats in Brussels, Le Pen is a very real threat. She has promised, come hell or high water, to take France out of the Euro and renegotiate the country’s relationship with its continental colleagues. This would make the Brexit process look like a storm in a teacup given the existential role that France has in the union.

Some are calmed by the thought that even if either of the two leading candidates get in, they couldn’t actually affect much change. Neither have much in the way of momentum for the legislature. Le Pen has always struggled with nationwide elections as is shown by her current standing of just two of the 577 National Assembly’s seats. Macron’s En Marche, meanwhile, is still recruiting candidates and they hail from outside the current rank and file of career politicians. The new party’s never fielded candidates for any vote – national, local or otherwise.

Only the embattled Fillon would traditionally have been able to rely on the backing of his mainstream party, but he too would face issues given that last year’s nomination process led to divisive splits that have only deepened as each scandal has hit.

But what does all this mean for the markets and portfolios? With Brexit, it took less than a week for the markets to snapback from initial lows. With Trump it was less than a day. But both those scenarios highlighted that, while nothing fundamentally had changed in the immediate aftermath of the votes being counted, markets moved and some – such as Sterling – moved significantly.

So here’s our starter for seven as to how some asset classes may react:

Le Pen Macron
Euro Stoxx 50 While Europe has to date overcome political hurdles – albeit somewhat ungracefully – this may be a hurdle too far. The threat of a radical rethink on the EU’s future may mean investors flee for the (safe haven) hills.However, the FTSE 100’s performance post the EU Referendum has taught us that investors can look beyond the headline French stock names given their international earnings’ profiles. And let’s not forget they make up less than 40% of an Index looking to cover 11 Euro zone countries. The region’s good economic backdrop may also help here. So, we have different positions depending on the risk profile. For the more cautious clients, we have trimmed back our exposure. For riskier investors, we remain firmly invested, stomaching the market moves in the interest of any longer term potential gains. Macron’s promises to make France a more business friendly environment – e.g. his desire to make the 35-hour week optional – and his affirmed intent to move European integration further forward would help the stock market, especially if investors hope to see less regulation. And while Macron may have a low likelihood of being able to actually get things done, investors would view his experience and intentions favourably and possibly see the limited level of change as a positive reason to invest. Furthermore, European companies are having one of their best periods for earnings since the financial crisis – growing revenues rather than cutting costs. This scenario could lead to fresh fund flows into Europe.
Euro Le Pen has promised to pull France out of the Euro and launch a new Franc. This would effectively provide France with a devalued currency to encourage French exports and manufacturing. However, while Le Pen may never have the influence over the National Assembly to achieve her plans, the uncertainty could put the Euro under pressure more immediately. A Macron victory would support the Euro. Recent political uncertainty has tended to play out in the currency markets. However, Macron represents the best option for the status quo to continue and the continental political union to remain unchanged. This could help the Euro to strengthen as uncertainty would fade.
FTSE 100 Investors have continued to invest in the globally diversified FTSE 100 given its companies enjoy 75-80% of their earnings from overseas. And we see little real reason for change, although a strengthening Pound against the Euro could lead investors to take their profits and move their money to better opportunities elsewhere. While Macron has signalled that he would be tough in Brexit negotiations, the index has proved to be resilient. We expect that strength to continue given the level of overseas earnings that are increasingly valuable in Sterling terms each time the Pound falls further against a peer.
Sterling If Le Pen were to win, the prospect of currency weakness in the Euro could lead to a rally in the Pound. The issues posed by changing views on the EU from Paris would sideline any Brexit negotiations as the EU would be unable to present a united front to the UK. This would probably lead to a better Brexit deal, not least as Britain’s desire for limited freedoms in the movement of people are very aligned to those of Le Pen. Macron could potentially signal a harder road to Brexit given his desire to protect the single market, and we have already seen Sterling affected by what type of Brexit we may encounter. While this would only be one such pothole in the bumpy road to Brexit, it could be a catalyst to send the Pound lower. Some fear that the Pound could even reach as low as US$1.10 during the negotiation process. 
US equities The US economy is solid and that message is clearly trickling down to the man on the street – consumer confidence is at highs not seen since the start of the millennium. However, we have already sold down our US equity holdings as we believe that the US market is not likely to move much higher. As with US equities, we see a Macron victory having little effect on Treasuries given the scenario represents the status quo for investors.
US Treasuries US Treasury yields have stabilised throughout the quarter, despite two interest rate hikes by the Federal Reserve (Fed). The current message from the Fed is being well received by markets, so we are less worried about a shock spike in rates. A Le Pen victory could however push yields lower if demand comes through for this safe haven asset of note. As with US equities, we see a Macron victory having little effect on Treasuries given the scenario represents the status quo for investors.
Japanese equities Japanese GDP growth forecasts are moving upwards, as are company earnings forecasts and Shinzo Abe’s extension as head of his party provides political stability (a rare thing currently!), although he is under media scrutiny in the short term. We believe this all bodes well for Japanese equities, but a Le Pen victory could provide a further relative boost as investors seek opportunities away from Europe’s political risk. While we believe Macron would not change international investor views about the markets in general, we still think Japan represents an opportunity for investors, particularly since Japanese equities still represent relatively good value versus some of the more overbought indices such as the FTSE 100 or S&P 500.

 

 

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