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What Do the French Election Results Mean for Markets?

Wells Fargo Investment Institute - April 24, 2017

Analysis and outlook for the global economy

  • The first round of the French presidential election makes it likely that a centrist reformer will be the next president. Voters’ choices will become clear after the May 7 final vote.
  • Financial markets reacted with relief rallies, but we still see political uncertainties as an ongoing risk to balance with Europe’s incipient economic and earnings recovery.

What it may mean for investors

  • Our balanced view between economic growth and political uncertainty does not change our recommendation to hold target allocations in developed-market ex-U.S. equities and below-target allocations in local-currency developed-market sovereign debt.

Download the report (PDF)

2017 marks the 60th anniversary of the European Union’s founding with the Treaty of Rome. In the nearly 30 years since the fall of the Soviet Union, Europe’s external reason for sticking together has faded, and internal divisions have (re)emerged—none greater than the gap that is widening between the top and the bottom echelons of living standards in the Eurozone community. Voter dissatisfaction has given new life to long-dormant nationalist and other movements that oppose the union.

Into this time of challenge stepped the French electorate, which voted in the first round of the country’s latest presidential election on Sunday, April 23. In a field of 11 candidates, Emmanuel Macron, an independent centrist, came out on top with 23.9 percent of the vote, ahead of Marine Le Pen, the far-right candidate, with 21.4 percent of the vote (according to French Interior ministry figures based upon 97 percent of the vote counted). Both advance to the final round runoff on May 7. Ms. Le Pen’s success marks the best performance ever for a far-right candidate and the first appearance in the second round since her father made it in 2002.

Market Reaction

Financial markets reacted positively to the fact that Mr. Macron and his pro-euro, pro-reform agenda advanced. Immediately after the election, the euro appreciated to a five-month high against the U.S. dollar, and European equity markets also cheered the results. Outside of Europe, Asian markets and U.S. equity futures prices also were higher. French government bond yields narrowed versus German government debt yields of comparable maturities.

What’s Next?

In our view, the April 23 election outcome reduces the immediate risk to the European economic recovery, which has gained traction on economic reforms that have improved sentiment. In particular, the first round reduces the recovery’s risk from a runoff election between Mr. Mélenchon (from the far-left, “Unsubmissive France” party) and Ms. Le Pen. These two candidates represented euro-skeptic, anti-reform, and anti-globalism views.

Markets can take further comfort from the fact that, even if Ms. Le Pen were to win on May 7, she would be very limited in her ability to take France out of the European Union. To do so, she would need a majority of the National Assembly (lower house of the French legislature), where her party holds only two of 577 seats and virtually no prospect of a majority or even a coalition.

Yet, a faster economic recovery depends at least as much, in our view, on the pair of national elections for the French National Assembly on June 11 and June 18. The Assembly is dominated by the Socialists and the Republicans (center-right party), the establishment parties whose poor showing in the presidential race (only 25 percent of the vote between the two) implies that the new French president will be unallied with the likely majority in the Assembly. Thus, we expect some caution in financial markets to continue.

What is Likely to Occur Later?

If Mr. Macron wins the presidential election runoff and can implement the reforms he has promised, French growth could accelerate and other countries may copy the approach. Until then, the trend remains toward voter dissatisfaction with traditional politicians and policy solutions. France’s far-left and far-right parties outpolled the establishment parties by a combined total of approximately 40 percent to 25 percent. The growing preference for anti-establishment politicians has been a consistent theme in Europe since Greece’s left-wing Syriza party swept to power in January 2015.

We also are watching Italy, where slow job growth leaves the current government in a fragile position. By law, Italian elections must be held by February 2018, but a new political crisis could force the current leadership out and trigger early elections—an outcome we think is not fully accounted for in financial markets.

What Should Investors Do Now? Key Takeaways

Economic improvement in Europe should continue, but populist pressures probably will inject uncertainties, especially around elections—but also around the extent of reform progress for the coming years.

Developed-market (ex-U.S.) debt in local currency: We remain underweight developed-market ex-U.S. sovereign debt as many developed-market yields remain below Treasury yields despite often-weaker fundamentals. While French election relief may boost the euro in the near term, we believe that, over the course of the year, factors such as interest-rate divergence between the U.S. and Europe, and remaining political and economic risk from Italy, will result in modest appreciation of the dollar versus the euro.  However, wide swings are possible over the course of the year given increased policy uncertainty. Given this more uncertain currency picture, and the fact that we are already exposed to a stronger dollar through our underweight position in this asset class, we do not recommend increasing the pro-dollar position by hedging any portion of developed bond holdings.

Developed-market ex-U.S. equities
: We recommend that investors hold international developed-market (ex-U.S.) equities at their long-term target allocation, because we see balanced risks between improving earnings growth and political uncertainty. In fact, this growth improvement led us to recently raise our year-end 2017 target price range for the Morgan Stanley Capital International Europe, Australasia and the Far East (MSCI EAFE) Index by 7.6 percent, to 1790-1890, based on an increase in earnings to $115 per share.

Above all, we recommend that investors remain internationally diversified. Now that economic growth is positive in both the U.S. and Europe for the first time since the debt crisis, we recommend diversification as one way to hedge the political risks that we believe will persist on both sides of the Atlantic.