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Analysis and Market Impact
The French presidential elections remained uncertain until the end:
- Four potential candidates for the second round: François Fillon, Marine Le Pen, Emmanuel Macron and Jean-Luc Mélenchon,
- Two pro-Europeans (François Fillon and Emmanuel Macron), two Eurosceptic or even Europhobes (Marine Le Pen and Jean-Luc Mélenchon),
- A candidate of a traditional party (François Fillon), a candidate without an official party (Emmanuel Macron), and two "extremist" or "populist" candidates, one from the right (Marine Le Pen), one from the left (Jean-Luc Mélenchon).
In short, 4 candidates, 3 men, 1 woman and 6 possible outcomes.
The polls were tight to the end, though with one pair constantly leading the race: Emmanuel Macron and Marine Le Pen.
Second round of the elections: A duel Macron – Le Pen
The first round finally delivered its verdict: Emmanuel Macron (En Marche!) arrived in the lead with 23.9% of the votes, ahead Marine Le Pen (Front National) with 21.4%. It is therefore between these two candidates that the future President of the French Republic will be chosen. François Fillon (Les Républicains) got 19.9% of the votes, Jean-Luc Mélenchon (La France Insoumise) 19.6%, Benoît Hamon (Parti Socialiste) 6.3%, Nicolas Dupont-Aignan 4.7%, Jean Lassalle 1.2%, Philippe Poutou 1.1%, François Asselineau 0 .9%, Nathalie Arthaud 0.6% and Jacques Cheminade 0.2%.
The rate of abstention was around 21.8%, a decent score in recent history, in comparison with previous presidential election first rounds (20.52% in 2012, 16.22% in 2007, 28.4% in 2002, 21.6% in 1995, 18.6% in 1988, 18.9% in 1981). One of the stakes of the second round will be to mobilize this electorate without conviction.
We saw for the second time in four presidential elections, the disappearance of the candidate of the traditional left (the Socialist Party); for the first time, the disappearance of the candidate of the traditional right ("Les Republicans") and the presence of a candidate without an official political party (E. Macron). It is in this sense that the French election represents a strong break with the past.
What do the polls say for the second round?
Until now, the populists, although they have been announced or feared, have not been able to take power neither in Italy, nor in the Netherlands, Austria or Spain. This will also be the case for Germany, with the two leading candidates (accounting for more than 60% of voting intentions) are strongly pro-European candidates (Martin Shultz and Angela Merkel).
As regard France, the polls institutes had so far analysed the six possible binomials: Macron - Le Pen, Le Pen - Fillon, Fillon – Macron, Le Pen - Mélenchon, Macron - Mélenchon and Fillon - Mélenchon. What emerged from the different scenarios was that Macron remained in the lead in the second round, regardless of the opponent, that Marine Le Pen did not win the election in the second round regardless of the candidate, and that a Francois Fillon's victory would prove complicated given the percentage of undecided.
As for the Macron – Le Pen binomial selection in the first round of elections, the latest polls indicated that the percentage of undecided was less than the difference between the voting intentions for the two candidates, which gives "some comfort" for the election of E. Macron. But let's be clear: the percentage of undecided and the probable reduction of the abstention rate (as is the case in each second round of presidential elections - 8 points in 2002 and 2 to 3 points on average) add uncertainty.
Let us recall, however, that in the French elections, whether national, regional or local, the transfer of votes has so far led to the elimination of the "extremist" parties: the right either withdraws or votes for the left (and vice versa) to avoid the election of the candidate of the National Front, for example. It was thus (but not only for this reason) that, after having made nearly 17% of the votes in the legislative elections, the National Front had finally obtained only 2 seats of representatives in the National Assembly (0,35% of the seats). François Fillon and Benoît Hamon already announced they would vote for E. Macron and recommend their supporters to do the same. Some other candidates reject the Front National officially but do not want to give voting instructions.
The programs of both candidates at a glance
The table below is based on the candidates' programs and on the website of the French newspaper "Le Monde". We added colour for the two candidates who are qualified in the second round: a blue colour for E. Macron, orange for M. Le Pen, and purple for the points of agreement. The same colours have also been added for each beaten candidate, considering the proximity to either Le Pen, or Macron, and this has been done measure by measure. This is important because the electorate of the beaten candidates will obviously have to vote either for Emmanuel Macron or Marine Le Pen. Some comments from the table below:
- In terms of security and immigration, François Fillon and Marine Le Pen are the closest;
- In economic matters, François Fillon and Emmanuel Macron are close, as are Jean-Luc Mélenchon and Benoît Hamon;
- As far as Europe is concerned, François Fillon and Emmanuel Macron are also very close;
- Apart from a few specific measures such as universal income, Benoît Hamon is a "sort of combination" of Jean-Luc Mélenchon and Emmanuel Macron;
- On some subjects (not the most important, and not the most numerous, let us admit), there are strong similarities between Macron, Fillon and Le Pen.
Ahead of the second round of the presidential elections, several conclusions must be drawn:
- A large part of the electorate of B. Hamon will turn to E. Macron;
- A (large) part of the electorate of F. Fillon will go to E. Macron, and another part - a smaller one - will go to M. Le Pen;
- The electorate of J.L. Mélenchon is not supposed to choose one of the two candidates in the second round, as the divisions remain strong. A large part may turn to E. Macron, though;
- The electorate of N. Dupont-Aignan (democrats and anti-europeans) might hesitate between E. Macron and M. Le Pen.
The table below refers to the main programs and cleavages at the dawn of the second round, as well as indications of their "proximity" (blue for "Macron group", and orange for "Le Pen group", purple for consensual measure).
Europe, the big stake of the second round?
Several points emerge from the analysis of the programs of the main candidates (those who are in the second round and those whose vote deferral is likely to weight in the balance):
- For Emmanuel Macron, the emphasis is on tax reduction, reforms (flexi-security), innovation and investment, and budgetary rigour;
- For Marine Le Pen, the rejection of Europe (more moderate in the run-up to the elections), the fight against immigration, restoration of sovereignty (monetary, political, budgetary and territorial) are the main battlegrounds;
- For François Fillon, priority has to be given to the (reduction in) taxation, the fiscal discipline required for better control of the debt, and reforms (labour market in particular);
- Jean-Luc Mélenchon insisted on taxation (rising taxation for the richest), sovereignty and Europe (let’s change it or leave it). This last point became unclear lately;
- Finally, Benoît Hamon developed his campaign on themes such as universal income or the need to change the governance of Europe.
The proposed measures (fiscal and tax stimulus, sovereignty or subsidiarity ...) run counter to European rules (Le Pen, Mélenchon and to a lesser extent Hamon) or have the ambition to consolidate European integration (Macron and Fillon). Furthermore, since the French electorate favours the EU and EMU, hostile speeches against Europe have recently been mitigated by the two extreme candidates, Le Pen and J.-L. Mélenchon. But the inconsistency remains between the desire to regain sovereignty (monetary, fiscal, political, diplomatic and even territorial) and to stay within the EU / EMU.
The debates preceding the second round will undoubtedly focus on these themes, as they will determine the scope and direction of voting transfers.
Looking at the results and at the usual transfers of votes (the right wing parties voting for the left, and vice-versa, to eliminate extreme parties at second round of elections), it is reasonable to bet on a victory of E. Macron (the second round will take place on May 7).
What’s next? In less than two months (June 11 and 18), the French people will vote again for general elections (with the whole 577 deputies to be elected). Two key questions at this stage:
- Will the next President be able to gain a majority? The very weak performance of the Socialist Party favours a massive restructuring of the left wing, a positive factor for E. Macron. He may benefit from a large support from the leftists at the general elections. Note that, in the past, all the newly elected presidents won the general elections that followed the presidential one. But if Marine Le Pen is elected (not our scenario), she will be unable to gain a majority. As a consequence, the political situation (and reforms also, including referendum on the Constitution and on Frexit …) would be completely blocked.
- If the next President is not able to gain a majority, is a coalition possible? Certainly yes should we consider Macron as the next President. As the above table on the differences between Macron and Fillon point out, the programmes are not irreconcilable. We can consider that a large part of the right parties will accept to run the country and reforms with E. Macron if needed. Any coalition with Marine Le Pen would certainly be impossible.
What market impacts?
Extreme scenarios, including that of FREXIT (France's exit from the EU) have rapidly fuelled chronicles and comments, but they have not really been discounted into market prices, no doubt a proof of relative serenity in the run-up to the elections, … or proof of a strong underweight in portfolios and a wait-and-see attitude. Despite the race at the top of the polls of Marine Le Pen, the difficulties of François Fillon, the rise of Jean-Luc Mélenchon, and the fears of a scenario Le Pen-Mélenchon in the second round, the impact on the French and European markets has been limited overall:
- The OAT-Bund spread has risen by only about 30 basis points between the first of January and the day before the elections.
- The deterioration in spreads in peripheral countries was similar: +30bp for Spain, +45bp for Italy (also in response to specific political problems), +10bp for Portugal ...
- Slight degradation of sovereign CDS: + 25bp for CDS 5 years of France, + 8bp for Spain, +35bp for Italy, but -21bp for Portugal ...
- A performance of French financials similar to European comparable;
- Finally, it should be noted that the underperformance of French equity markets was only 2% compared to Germany or the United States.
In the awaiting of the second round opposing Marine Le Pen and Emmanuel Macron (the scenario with the highest probability for long), the market impacts should still be limited. The worst case scenarios (such as a second round Le Pen – Mélenchon) have evaporated, but part of the uncertainty remains. A final answer will be given at the second round of the Presidential elections, and at the general elections As such, a rush of investors into French assets is improbable. The continuation of the wait-and-see attitude is certainly more likely in this environment … but a positive mood on French financial markets is also possible. The major lesson from the presidential election is the elimination of the Frexit scenario, which is a very important step. This positive news should materialise into a feelgood mood on financial markets..The elimination of extreme scenarios will favour an appreciation of the euro, a decline in OAT/Bund Spread and an increase in French bonds and equities.
View direct from our CIOs
We have gradually moved towards a more cautious portfolio positioning both in terms of duration and exposure to risky assets. This prudent view is not only linked to the coming French elections but also to remaining uncertainties, particularly with regards to the US budgetary policy and the FED decisions.
However, we still favor certain Eurozone equities and credit in light of improving fundamentals and lack of anticipated impact following the first round of French presidential elections.
Finally, we maintain a good level of liquidity in our portfolios, in order to be able to adjust our positions should any opportunities materialize.
Fixed income portfolios
- Underweight Eurozone rates, where possible
We remain generally underweight duration across our fixed income portfolios, though significantly more on our international portfolios compared to our euro portfolios. We are also underweight Eurozone risk in our international portfolios. However for our euro-denominated portfolios we have less margin to mitigate a risk that, in reality, will impact the entire investment universe.
- Within the Eurozone, an overweight position in peripheral sovereign risk.
Our positions continue to favor “risky” assets, with more exposure to peripheral Europe than to the "core” Europe. However, our strong underweight position in Germany (negative position) has been somewhat reduced in recent months in the euro portfolios, to anticipate large inflows to this region in the event of market turbulence.
- Within the Eurozone a preference for Corporate risk.
The corporate sector has the advantage of providing a form of hedge against sovereign risk, though likely to be marginally effective in the event of a major market shock.
- A search for the highest possible liquidity
In this context, a fundamental part of risk management lies in seeking the highest level of liquidity of selected assets in order to keep some leeway in stressed markets.
In short, we seek to construct liquid, diversified portfolios with a range of high-quality issuers In view of the forth coming French Presidential Election, our current risk mitigation strategy is therefore to remain underweight Eurozone bonds in international portfolios (for both active and currency positions) and overweight credit in the euro portfolios.
Equity portfolios have benefited from a very favorable year-to- date trend which has seen stock markets supported by the anticipated earnings recovery, along with the ongoing nominal GDP recovery. Economic indicators remain strong and have helped equity markets to price in the 3 Fed rate hikes expected in 2017.
- Some investment opportunities within a globally positive trend.
The elections results could influence the value of the euro currency. The removal of uncertainty will likely cause markets to rebound as we have seen with the Brexit and Italian referendums. Any setback would be an opportunity to overweight EMU stocks. In addition, further political tension is expected to result in prolonged ECB intervention.
Political events are likely to have a marginal impact on the overall stock market performance. Indeed, they are more likely to create slight country performance divergence within Europe rather than cutting short the more general recent upward trend. In fact, we anticipate only very limited performance divergence between continents and within Europe.
- European and Japanese equity markets overweight versus US equities
The US equity market, however, is already very expensive and good economic news could eventually burst the bubble. Japan (hedged), European Equities and some emerging markets are still deserving of overweight positions at the expense of US equities.
- A cautious stance within the Eurozone
Within the Eurozone we have taken a more cautious stance and reduced country bias whilst we wait for the uncertainties linked to the French Presidential election to abate.
- Specific attention on company earnings
Earnings were and should remain in the driving seat. If Forex, followed by bond markets, are more liable to be impacted by political events, Equities are then generally influenced by these market movements especially when it comes earnings.
- A preference for Value, Dividend yield and the Reflation play
With regards to investment styles, value and dividend yield factors are should continue to work well for Europe, especially if political uncertainties causes the prolonged low interest rate environment to persist.
It should also be noted that many overseas investors moved away of European equities in the summer of last year thus limiting risk associated with potential outflows.
The results of the election expected within 2 weeks will not fundamentally change our view of the market, where risk premia has generally become scarce.
- We remain long risky assets
Our portfolios retain a moderate risk bias with a targeted overexposure to Euro zone stocks, Euro zone peripheral debt (which remain undervalued despite improving fundamentals) and certain diversification securities (gold, Japanese equities, etc.).
- Reduced duration
Portfolio duration has been gradually reduced and is set to remain low especially for core European sovereign debt.
- Macro hedging in case of uncertainties
The environment remains uncertain. Looking beyond the French presidential election, the US budget horizon should also be an important stimulus for markets. Given this context, we have chosen to maintain macro-hedge strategies including exposure to volatility (via put options and volatility funds) and remain overweight the US dollar and the yen.