Head - EMEA Investment Strategy
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Investors relieved as centrist to face extremist in the final round
The first round results of the French presidential election were close with the top contenders as: Macron 23.5%, Le Pen 22.1%, Fillon, 19.6%, Melanchon 19.3% and Hamon 7%. Turnout for the French election was high at almost 80. For the first time in six decades, candidates from France’s two major parties will not be present in the second round.
This result is a powerful positive boost for Eurozone markets, because the worst-case has been avoided of two extremists Le Pen and Melanchon, competing in the second round. In addition, while Le Pen’s National Front gained its most votes ever in a general election, she didn’t win with a high 20s percentage as seemed possible a few weeks ago.
European equities are up 3.7% so today, with the French index up 4.1% led by the bank sector up 8%. French rates have tightened by around 15 basis points, and the 10-year French OAT has moved back to a spread with 10-year German Bunds of around 45 basis points from more than 60 basis points Friday. The Euro reached a high in Asian trading of 1.0940 versus the USD and has eased to 1.086 (up 1.3% on the day), triggered by short-covering and stop-loss orders.
The two contenders in the second round have radically different views. Macron aims to restore French influence in Europe, adapt France to a globalized world, cut corporation tax, strengthen the relationship with Germany, and create a taskforce to fight terrorism. Le Pen is anti-EU, anti-Eurozone, anti-immigration, ultra-protectionist, and wants to reduce the retirement age to 60. There remains residual uncertainty over the next fortnight, and also after the winner is announced. These are three things to consider:
The French first round result lowers French and European political risk and this could be confirmed with an eventual Macron win. Nevertheless some European political risk would remain, with elections in the UK, Germany, and probably Italy to navigate in the next ten months, as well as the Brexit negotiations intensifying. So European assets might face less immediate downside risk and their relative attractiveness could increase slightly, however expect volatility to rise and selectivity to increasingly matter as equity and fixed income indices are not cheap in absolute terms. The discrete possibility of a Le Pen/Melanchon first round had concerned markets significantly. Now that this won’t be the case, we would expect the bulk of a relief rally – re-rating Eurozone risk – to largely take place over the very short term.
The CPB Global Investment Committee meets this week. The current risk-level 3 weighing for French equities is 1.1% versus a strategic benchmark weighting of 1.3%, and overall Europe equities are weighted 7.9% versus the strategic benchmark of 8.5%. The European high yield weighting is overweight at 0.8%, versus 0.4% strategic, the European investment grade weighting is neutral at 2.1%, and European sovereign bonds are underweighted at 6.4% versus a strategic benchmark weight of 8.4%.