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Marcuard's Market update by GaveKal Dragonomics
By Cedric Gemehl
For once the opinion pollsters got things right. Although the candidates of France’s traditionally dominant left and right wing parties were both eliminated in Sunday’s first round presidential election, the political center held. Independent Europhile centrist Emmanuel Macron emerged with the largest share—23.9%—of the vote, for a second round face-off against nationalist Euroskeptic Marine Le Pen, who captured 21.4%.
This result laid to rest investors’ two worst fears: (i) that a large cohort of “shy voters” would declare for Le Pen, bumping her up into first place and making her the second round favorite; (ii) that the second round would pit against each other the candidates of the far-right and far-left, both avowed Euroskeptics. With these risks removed, the euro rose strongly in Asian trading, rising 1.1% versus the US dollar and 2.2% versus the yen.
Beyond this immediate moderation of the political risk premium, there are several important takeaways for investors from the first round vote:
– Both the opinion polls and a more qualitative political analysis point to a clear-cut second round victory for Macron. Polling immediately after the first round result showed Macron winning the run-off with a 62% share of the vote. In support of this outcome, not one single earlier poll showed Le Pen winning in the second round if she were to end up facing Macron.
– Despite Le Pen’s efforts to detoxify her party’s brand, many French voters remain viscerally opposed to the far right. Their distaste will support Macron in the second round. Polls indicate that 60% of far-left voters are likely to swing behind the centrist candidate, with only 10% shifting to the far-right. Similarly, of centre right-voters, 50% are likely to support Macron in round two, with only 30% plumping for Le Pen.
The failure of candidates from either the centre-right Republican party or the “official” Socialist party to make it through to the second round of the presidential election could have important implications for France’s parliamentary elections which follow in late May/early June.
1. The electorate could revert to their historical allegiances and vote for the traditional parties of right and left. In that case, Macron—if elected president—will fail to command a clear majority in a fractured parliament. To govern effectively, he will need to win the support of a coalition dominated by the Republicans, who are likely to emerge as the single largest party in the legislature.
2. A large number of voters who backed Macron for president could also back his En Marche! party in the parliamentary election. In that case, En Marche! could form the core of a new government in alliance with both centre-right Republican representatives and centre-left Socialists.
Either way, the centre is likely to hold in the parliamentary election, allowing the government that is subsequently formed to push ahead with structural reforms. The pace of reform may not be as fast as some on the centre-right would wish.
Nevertheless, the new government will enjoy a powerful tailwind from improving cyclical conditions. With this month’s French flash composite PMI at 57.4, its highest since May 2011, French businesses are increasingly optimistic and unemployment looks set to fall further over the coming quarters.
This will all bode well for European risk assets.
After the failure of far-right candidates to win either the Dutch or French elections, investors will conclude that the populist political wave which led to the Brexit vote and Donald Trump’s presidency in the Anglo-Saxon world will not spread to continental Europe. As a result, the risk premium on European assets should fall considerably.
As an ardent Europhile untainted by scandal, Macron is well-placed to work to bring new strength to the Franco-German axis on which European integration has always turned.
If elected France’s president, Macron is likely to use the months before Germany’s federal election in September to enact one or more symbolic reforms as a demonstration of his intent to undertake more meaningful structural reform. In doing so, he will hope to persuade Germany’s new Chancellor of France’s whole-hearted commitment to the European project, so potentially opening the way for more stimulative policies from Berlin to redress the eurozone’s internal imbalances.
In short, Sunday’s first round French election result will reassure investors that the populist wave has broken on the rock of the European political centre. Against a backdrop of an accelerating cyclical upswing, the increased potential for business-friendly reforms in France and the prospect of a revived Franco-German consensus at the heart of the eurozone will focus international investors’ attention on the relatively attractive valuation of European equities.
