Chief Investment Strategist
On Mondays we normally write about asset allocation and macro trends, but today we are making an exemption analysing the French election with the first round coming up this Sunday and its impact on French equities and bonds.
France is headed for a snap election as Macron reacted swiftly to his party’s devastating results at the EU parliamentary election with his party getting close to half of the votes that Le Pen’s party National Rally got. In an interview over the weekend Macron explained his decision which many described as reckless. In his view the opposition parties would have teamed up to dissolve his government later this year so he had no choice but to pre-empt that move.
The French election is a complex two-round process (on 30 June and 7 July) which is well explained in this Politico article. What we know at this point is that National Rally is leading ahead of the first round election on Sunday with almost 35% of the voters according to a Bloomberg composite figure. The leftist alliance New Popular Front comes 2nd at around 28%, and Macron’s Renaissance party and its allies come in 3rd position at 21%.
Things can still change and it is too early to get firm on the outcome, but it does look like the probability is high that France will undergo a political change. Emmanuel Macron will still sit as President of France until his term runs out in 2027, so the election is about the legislative composition in parliament.
The market has so far expressed a negative view on France ahead of the election with French equities selling off and the French government bond yields widening against German government bonds. Is the market overreacting? In a Financial Times article today, the French CEO of Euronext, Stéphane Boujnah, says that French business leaders should stay “calm” as multiple institutions ranging from labour unions to credit agencies constrains French politicians on their ambitions. We have seen many times that things often do not go as fast as the market thinks when it comes to politics, and often the political rhetoric outstrips realities when in office.
Meloni has been serving as the prime minister of Italy since October 2022 and is potentially a good guide for how to interpret French politics post the election. There were initial fears regarding her government as she boasted Euroscepticism and had expressed economically unsustainable policies.
However, reality has turned out very differently with her administration taking a more pragmatic approach adhering to fiscal conservatism and a continuation of post-pandemic economic reforms set by predecessor, Mario Draghi.
Meloni has carried out pragmatic economic policies aligning closely with EU requirements and alleviating markets’ fears over Italy with Italian equities rallying to all-time highs and bonds yields behaving well.
Markets feared Meloni due to her Eurosceptic stance, but she has sought collaboration with the EU on issues such as immigration and securing funds for the EU’s National Recovery and Resilience Plan (PNRR). She also embarked on ambitious international initiatives such as the Mattei Plan for Africa aiming to enhance Italy’s role as a Mediterranean energy hub.
The Meloni administration proved to much more pragmatic than feared and there is a high likelihood that National Rally, if they win the French election, will also be more pragmatic than currently perceived. In that case, there might be an attractive investment case to be made in French equities and bonds as we have seen in Italian markets.
The market’s current fears about the outlook of National Rally winning the election is very well expressed in two charts on French equities and government bonds.
The first chart shows the dismal performance of French equities this year driven by a combination of weak luxury goods demand and recently the EU parliamentary election outcome in France decimating Macron’s party. French equity market is only up 4.6% year-to-date compared to 10.8% for the broad European benchmark STOXX 600 and 15.1% for Italian equities. French equities have also been valued at a valuation premium to Europe for many years, but ahead of the French election this has turned into a discount. French equities valued at 12.9x 12-month forward earnings compared to 13.7x for European equities and 9.0x for Italian equities.
The bond market is always a good place to look for how institutional investors are viewing things. Since Macron called for the snap election, the France-Germany 10-year yield spread has widened to around 80 basis points which is a level not seen since the euro crisis back in 2012. It reflects a bond market that wants to be safe rather than sorry depending on what signals Le Pen and Jordan Bardella send after the election, in the event that National Rally wins the election. Investors are worried about France’s relations with the EU and also the fiscal trajectory, given that many of the policies laid out by National Rally could lead to higher deficits. But all of this is speculation at this point and the market might turn bullish on France faster than we think is possible if Meloni’s period in office in Italy is any guidance.
In currency markets we also observe traders buying downside protection on the euro to safeguard portfolios should the market view the French election outcome as bad for the EU and the euro. It is worth remembering that, often when the market has expressed a negative view on the euro it has never turn out as bad as expected. As we indicate in our first part of the analysis, we believe the market is potentially overreacting to the French election and that Meloni’s period in Italy serves as a good guide on the key constraints that European politicians face after getting into office.
When we look at equity market performance among the single stocks in the CAC 40 Index since the EU parliamentary election, there is a clear picture of what the market believes.
At the bottom we find the financials such as Societe Generale, Credit Agricole, and BNP Paribas as markets are nervous about what a National Rally win would mean for financial regulations and potentially future economic growth. Le Pen has previously talked about separation of investment banking and retail banking. Among the worst performing stocks, we also find utilities such as Engie and Veolia Environment as markets are worried about changing utility regulations, which could include changes to policies around renewable energy projects and policies supporting French households on their electricity bills.
Among the best performing stocks we find EssilorLuxottica, Schneider Electric, Airbus, Michelin, Accor, Danone, Safran, and Vivendi. It seems markets think that these companies could benefit in a political environment with a stronger focus on the domestic economy and protecting French industry. The relatively good performance of Safran is a reflection that the market is not nervous about support for the defence industry as National Rally president Jordan Bardella has said that he supports Ukraine getting the ammunition they need to defend themselves.
The Nobel prize-wining quantum physicist Niels Bohr famously said “It is difficult to make predictions, especially about the future”, which is especially true when it comes to financial markets. But markets’ view expressed in French single stocks gives a good guidance for investors. Either momentum continues post the French election or the divergence is closed to some degree. This is really the key question any investor must ask.
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