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- The possibility of a pro-European presidency capable of leading with a majority or a coalition has emerged, replacing the extreme risk of an anti-European populist party taking power without a parliamentary majority;
- The waning of systemic European risk and specific French risk is reflected in the markets as riskier French assets begin to recover.
- Much of the uncertainty has lifted and we can now look at France and the French markets with a much lower risk premium, focusing on its fundamentals;
- The environment is once again favourable for equity and credit markets (especially the higher beta segments), thus our positions remain unchanged;
- Reduced risk premiums go hand-in-hand with a lower OAT-Bund spread;
- We have reduced macro-hedging positions;
- (Weak) US growth, the Fed, the ECB and "Trumpflation" are once again the centre of concerns;
- Returning to fundamentals should pay off for the EMU and also for emerging markets.
The Key Messages of the 1st Round of the French Presidential Elections
The first round of the French presidential elections has delivered its verdict: it will be a battle between Emmanuel Macron and Marine Le Pen. Five key messages emerge from this first round of voting:
- France's polling institutes did not fail: they had long predicted this duel and even the order of results for all the candidates;
- According to the polls and given the result of the vote, E. Macron will in all likelihood be the next President of the French Republic;
- The extreme risk scenario of a battle between Le Pen and Mélenchon has been ruled out;
- Frexit exits:the probability of aFrexit(France leaving the EU)has dropped to a level close to zero;
- The close to complete disappearance of systemic European risk and the specific French risk has been reflected by the markets -the recovery of risker French securities is bolstered by the underlying economic fundamentals.
Clearly, much of the uncertainty has lifted and we can now look at France and the French markets with a much lower risk premium, focusing on fundamentals. It is increasingly probable that the next president will be able to gain a majority of seats in parliament and thus be able to carry out the reforms announced in his programme. The traditional Right (Les Républicains) and Left (Socialist) parties will need to be rebuilt and it is easy to imagine that the new President will be able to garner a great deal of support. In short, instead of the extreme risk of an anti-European populist party without a parliamentary majority coming into power, a scenario has emerged of a pro-European presidency capable of actually running the country. And in all likelihood this will be supported by a strong Franco-German alliance, given that Angela Merkel and Martin Schulz, two steadfast Europeans, will be the last two candidates for the office of Federal Chancellor.
Back to fundamentals
Though the extreme scenarios - including the possibility of France leaving the EU (Frexit) - have been the subject of many a headline, they were never really priced into the market. This is possibly an indication of the relative serenity of investors with regards to the elections, strong underweight positions or perhaps of a wait-and-see attitude. Whatever the case, outright hostile or negative portfolio positions have not been the norm despite Marine Le Pen taking the lead in the polls, Francois Fillon's setbacks, Jean-Luc Mélenchon's late surge in the polls or even the fears of a Le Pen / Mélenchon duel in the second round. Overall, the impact on French and European markets has been limited.
Immediately after the first round, the least favourable scenarios (such as a second round duel between Le Pen-Mélenchon, or the prospect of aFrexit) have faded, but some of the uncertainty remains. It will be definitively lifted following the parliamentary elections on the 11th and 18th June. Even if overseas investors have not rushed to invest in the French market, we expect the relief rally will lead to an appreciation of the euro, lower long-term interest rates, a pickup in equity markets (especially the higher beta segments) and a lower OAT-Bund spread. This improvement in the French market stems in large part from the sharp reduction in political risk and the much improved economic situation. If we consider the fundamentals, we are able to discern a somewhat positive and tangible outlook:
- An improving economic situation,
- Investments on the point of picking up,
- Bank loans amongst the most robust in the EMU,
- Significant growth in loans to SMEs & VPBs,
- Improving preliminary indicators,
- Better profit prospects,
- A depreciated euro (in real terms) following the strong appreciation of emerging currencies since the beginning of the year,
- A low interest rate environment ,
- More budgetary latitude resulting from the sharp reduction in debt,
- Attractive valuations
- Generous dividend policies
- Particularly attractive dividend yields
What do we need to look out for?
We should not allow the fundamentals of the French economy to overshadow the international context:
- The possibility of disappointing US growth (Q1 GDP growth forecast was weaker than expected) is an asset for European and Emerging countries ;
- The Fed has initiated its accelerated monetary tightening plan, but the plan is dependent on growth and the Trump government's ability to make use of its budgetary and fiscal arsenal: the less room Trump has for manoeuvre, the less the Fed Will be able to pursue its policy of raising rates;
- The possible disappointment with "Trumpflation": budgetary and fiscal measures are slow to come, proof that the Congress and the Administration are struggling to find common ground;
- ECB to maintain ultra-low rates and continue its generous bond buying programme (it buys more than twice the zone’s net issues), but the debate over the how long it can continue to maintain these measure will no doubt re-surface later in the year. For the time being, short and long-term interest rates will remain in low Europe.
Amundi’s allocation views following the first round
- We maintain our preference for European Equities
- European long-term interest rates depend on economic activity indicators (which are rather good at the moment, even in Europe) and inflation which has slightly increased (though core inflation remains below 1%) . They also depend on D. Trump ‘s policies particularly budgetary, fiscal policies and monetary policies (ostensibly rather accommodative). All in all, it seems right not to be long European rates. We do not expect strong long-term rate rises in the euro zone, nor do we expect strong declines either.
- We remain overweight stocks vs. sovereign bonds, especially because the equilibrium rate is lower in Europe than elsewhere,
- We also remain overweight corporate bonds vs. Sovereign bonds,
- Peripheral and semi-core (France, the Netherlands in particular) European debt risk is to be maintained, given the current environment,
- We are waiting for the US Treasuries to improve before returning to this market. US sovereign bonds are of particular interest for the carry they offer, and also as a macro-hedge against possible difficulties in the emerging world or in Europe. This is less of interest currently,
- We continue to gradually return to emerging markets. In the medium term EM markets remain attractive with good valuations, often undervalued currencies, largely underrepresented in portfolios and potentially high capital flows. Thus we remain positive on this region.
- We remain very cautious towards the GBP. As we have repeatedly pointed out, Brexit represents an asymmetric risk. The most natural and simplest expression of this risk (actual or feared) will be on value of the sterling.
- Currencies like SEK and NOK remain of interest: they seem to be undervalued at this stage, with monetary policies very (even, too) accommodative.
- Macro-hedging strategies have been reduced. The global geopolitical context, diplomatic tensions between the United States and other countries (especially China) and the political context of Europe mean some protection measures are necessary (such as exposure to US Treasuries, volatility strategies, puts on equity markets, cash in USD and inflation-linked bonds). However, we have reduced hedges against European risk i.e. long volatility positions, long USD, long JPY, long US Treasuries.